This Week In Securities Litigation (Week ending October 10, 2014)

The Fifth Circuit decided a significant case on loss causation. The Court concluded that the truth could emerge from a series of disclosures which, in and of themselves were not sufficient to uncover the fraud, but which when considered together were adequate.

The SEC, after emptying out the pipeline of cases at the close of the government fiscal year, brought two actions this week. On is a proceeding against a current and former subsidiary of E*Trade for selling unregistered microcap shares. The other is an investment fraud action.


Remarks: Keith Higgins, Director of Corporation Finance, delivered remarks titled “Shaping Company Disclosure” before the George A. Leet Business Law Conference (Oct. 3, 2014). His remarks focused on the staff disclosure initiative, noting that they are considering if it should be more principle based and also the role of technology (here).

Alert: The National Exam Program issued a Risk Alert titled “Broker-Dealer Controls Regarding Customer Sales of Microcap Securities” in conjunction with the settlement of the E*Trade case discussed below (here).


Remarks: Commissioner Mark Wetjen addressed the Global Markets Advisory Committee Open Meeting (October 9, 2014). He reviewed the bilateral discussion on CCP equivalency and the NDF clearing mandate (here).

SEC Enforcement – Filed and Settled Actions

Statistics: This week the SEC filed 1 civil injunctive action and 1 administrative proceeding, excluding 12j and tag-along-actions.

Unregistered sale of securities: In the Matter of E*Trade Securities, LLC, Adm. Proc. File No. 3-16192 (October 9, 2014) is a proceeding with names as Respondents the broker-dealer and G1 Execution Services, LLC, formerly known as E*Trade Capital Markets, LLC. Both were subsidiaries of E*Trade Financial Corporation during the time period of this action. Beginning in March 2006, and continuing through April 2011, Respondents facilitated the sale of thousands of shares of unregistered penny stocks, apparently relying on Securities Act Section 4(a)(4), the brokers exemption. Clients repeatedly deposited shares of microcap stocks, claiming that they were free trading and directed that they be sold. The funds were wired out immediately. While Respondents conducted some due diligence initially, it was insufficient to claim the exemption. Later in the period additional inquiry was made but Respondents ignored several red flags and failed to conduct the kind of “searching inquiry” necessary. The Order alleges violations of Securities Act Sections 5(a) and 5(c). Respondents resolved the matter with each consenting to the entry of a cease and desist order based on the Sections cited in the Order and a censure. In addition, Respondents, on a joint and several basis, will pay disgorgement of $11,402,850, prejudgment interest and a penalty of $1 million.

Investment fund fraud: SEC v. Nationwide Automated Systems, Inc., Civil Action No. CV 14 07249 (C.D. Cal. Unsealed October 7, 2014) names as defendants the company, Joel Gillis and Edward Wishner, respectively, the president and treasurer of the firm.

Beginning in 1999, and continuing to the present, Nationwide and Mr. Gillis have offered securities in the form of ATM sale and leaseback agreements to the public. Since January 2013 the Defendants have raised about $120 million from investors through the sale of the ATM leaseback offering. Defendants used a standard set of agreements to implement their scheme which involved a sale of the machine and its lease back to the defendants. Nationwide agreed to pay the investor $0.50 for each approved transaction at the machine. In addition, the investor was guaranteed a return of 20% or more and was assured that the firm had a 19 year track record of success. Payments were in fact made to investors, largely from the funds of other investors. The Commission’s complaint alleges violations of Exchange Act Sections 10(b) and 20(a), Securities Act Sections 5(a) and (c) and of each subsection of 17(a). The case is pending. See also Lit. Rel. No 23106 (October 8, 2014).

Misappropriation: SEC v. Mannion, Civil Action No. 1:10-cv-03374 (N.D. Ga.) is a previously filed action against Paul Mannion, Andrew Reckles and PEF Advisors LLC and PEF Advisors Ltd., both co-owned by the individual defendants. The complaint alleged violations of Exchange Act Section 10(b) and Advisers Act Sections 206(1) and 206(2) based on claims that the defendants fraudulently overvalued certain assets of the funds: that assets were misappropriated and that misrepresentations were made to a stockholder in connection with a stock purchase; and that warrants belonging to a hedge fund client were inappropriately exercised. It was settled by instituting an administrative proceeding. That proceeding concluded with the entry of a cease and desist order against Messrs. Mannion and Reckles based on Advisers Act Section 206(2). In addition, each was barred from the securities business and from participating in any penny stock offering with a right to apply for reentry after two years. Previously, the Court granted the SEC’s motion for summary judgment on the stock warrant claim, finding a violation of Advisers Act Section 206(2) but also granted the defendants’ motion for summary judgment on the Section 10(b) claims as to the warrants and all claims as to the valuation allegations. The Commission then dismissed certain claims remaining and entered into the settlement. See Lit. Rel. No. 23108 (October 8, 2014).

Misrepresentations: SEC v. Eiten, Civil Action No. 1:11-cv-12185 (D. Mass.) is a previously filed action against stock promoter Geoffrey Eiten and his firm, National Financial Communications, Inc. The complaint alleged that the defendants published material misrepresentations in their penny stock news letter based on information from paying clients that were not checked. The Court entered a final judgment this week, enjoining Mr. Eiten from future violations of Exchange Act Section 10(b) which included certain restrictions relating to penny stocks and a penny stock bar. The order also requires the payment of $605,262 in disgorgement, prejudgment interest and a civil penalty of $50,000. The firm previously defaulted. See Lit. Rel. No. 23107 (October 8, 2014).

Court of appeals

Loss causation: Public Employees’ Retirement System of Mississippi v. Amedisys, No. 13-30580 (5th Cir. Decided October 2, 2014) is a case in which the Court concluded that a series of small disclosures collectively were sufficient to establish loss causation.

Amedisys provides home health services. About 90% of its revenue came from Medicare payments. During the class period Medicare paid a flat fee for the treatment of a patient with at least five but fewer than ten therapy visits per episode – a course of treatment over sixty days. More was paid if there were over ten visits. In 2008 Medicare revised the rules, dropping the ten visit threshold in favor of paying increased reimbursements upon the occurrence of six, fourteen and twenty visits during an episode for medically necessary services. Plaintiffs claim that the company committed fraud by pressuring employees into providing medically unnecessary treatment visits to hit the more lucrative reimbursement thresholds. The officer defendants made a series of false statements. The truth finally emerged through a series of five partial disclosures, according to the complaint. The share price dropped, injuring plaintiffs.

The district court found the five partial disclosures insufficient to reveal the truth about the fraud and dismissed for not adequately pleading loss causation. The Fifth Circuit reversed. The five partial disclosures are: 1) A research report about firm’s accounting and Medicare billing practices; 2) The company President and CEO and its CIO resigned to pursue other interests; 3) A study published in the Wall Street Journal on Medicare reimbursements by a Yale professor analyzed payments to Amedisys, revealing a questionable pattern of home visits clustered around reimbursement targets that changed after the revision of the targets; 4) the fact that the Senate Finance Committee, the SEC and the DOJ all launched inquiries regarding the Medicare billing practices of the company following the Wall Street Journal article; and 5) the fact that the company announced disappointing quarterly results.

The critical question is whether the relevant truth emerged, the Court noted. Here each of the events may not be sufficient to establish loss causation, although the Wall Street Journal article added new information to the market in the form of an expert analysis of previously disclosed data. Collectively, however, “the whole is greater than the sum of its parts.” Together these facts are sufficient to demonstrate that the truth emerged, establishing, at this stage of the case, loss causation.

Hong Kong

Breach of duty: The Securities and Futures Commission obtained an order banning Ho Yik Kin, a former executive director of Tack Fat Group International, from serving as a director or being involved in the management of a public company for a period of six years. The order was based on admissions that he failed to fulfill his duties by signing minutes of board meeting in which significant transactions were undertaken when in fact he did not attend the meetings.


Client funds: The Financial Conduct Authority fined David Gillespie, Managing Director, and David Welsby, Finance Director of Pritchard Stockbrokers, respectively £10,500 and £14,000 (which would have been £144,000 and £72,000 but for financial hardship) and banned each from the securities business. The firm was also censured and would have been fined £4,932,600 but for its financial condition. The penalties were imposed for serious violations of the client money rules which require that such funds be kept in a segregated account. Specifically, client funds were kept in an opaque off-shore facility which was not supposed to be used and the funds were wrongly utilized to pay business expenses and shortfalls were not repaid. As a result there is a deficiency of about £3 million in client funds.

Libor manipulation: The Serious Frauds Office announced that a senior banker from a leading British bank pleaded guilty to conspiracy to defraud in connection with the manipulation of LIBOR.

Tagged with: , ,