This Week In Securities Litigation (Week ending October 13, 2017)
The Commission prevailed at the trial of Howard Present, a co-founder of F-Squared centered on the marketing claims for its AlphaSector product. That product was also the focus of a series of actions involving investment advisers who recommended it without conducting the proper due diligence about the advertising claims which were false.
This week agency also actions against three attorneys. Two were involved with the creation and sale of fraudulent blank check companies. A third was instrumental in the sale of unregistered promissory notes in a Ponzi scheme. The Commission also brought an action against four executives of Mexico’s largest residential home builder who repeatedly booked revenue from the sale of homes they never built.
SEC Enforcement – Litigated Cases
The Commission prevailed at trial last week, with the jury returning a verdict in its favor just hours after closing argument. SEC v. Present, Civil Action No. 1:14-cv-14692 (D. Mass. Filed Dec. 22, 2014). Defendant Howard Present was the co-founder and CEO of F-Squared Investments, Inc., a firm which had been a registered investment adviser since 2008. The firm at one time was the largest marketer of index products using exchange traded funds.
In August 2008 the adviser began creating a model portfolio of ETF’s in various sectors of the U.S. economy. A new quantitative algorithm that generated signals indicating when to buy or sell was acquired. The new AlphaSector portfolio of ETFs was to rebalance periodically based on the signals.
F-Squared launched the index in October 2008. It was marketed as having been a highly successful since at April 2001. The results were represented to be based on actual investments rather than calculated, hypothetical results or backtesting. In fact the claims regarding the results for the strategy were not true. In addition, the results, which showed substantial returns, were the result of a flawed process because of an inadvertent error. Mr. Present learned of the error in 2008 but took no steps to correct it. He was also the face of the advertising campaign for the new portfolio. The complaint alleged violations of Advisers Act Sections 206(1), 206(2), 206(4) and 207. The question of remedies will be considered by the court in future proceedings.
SEC Enforcement – Filed and Settled Actions
Statistics: Last week the SEC filed 6 civil injunctive cases and 1 administrative proceedings, excluding 12j and tag-along proceedings.
Beneficial ownership filings: In the Matter of Matthew T. Mellon, II, Adm. Proc. File No. 3-17571 (Oct. 12, 2017). From November 5, 2012 through January 24, 2014 he was a member of the board of directors of Medient, n/k/a Moon River Studios, Inc. whose shares were quoted on OTC Link. Respondent failed to file a Form 3 after becoming a director or a Form 5 after failing to make the earlier filing. The Order alleges violations of Exchange Act Section 16(a). Respondent resolved the proceeding, consenting to the entry of a cease and desist order based on the Section cited in the Order. In addition he will pay a penalty of $35,000.
Offering fraud: SEC v. JustInfo LLC, Civil Action No. 2:17-cv-07426 (C.D. Cal. Filed Oct. 11, 2012) is an action which names as defendants the firm, a day trading company; David Weddle, the founder and majority owner of JustInfo; and Scott Allensworth, a tax preparer. Over about eighteen months, beginning in September 2015, JustInfo, a claimed investment club, raised over $2.8 million from about 57 investors. The funds were pooled into a futures account. About $1 million was misappropriated by the individual defendants; investors were furnished with false account statements to conceal the fraud. The complaint alleges violations of Securities Act Sections 5(a) and 5(c) and each subsection of 17(a) and Exchange Act Section 10(b). The company and Mr. Weddle settled the matter, consenting to the entry of permanent injunctions based on the Sections cited in the complaint, and paying disgorgement and interest of $388,322.34 on a joint and several basis along with a penalty of $904,353. Mr. Allensworth is litigating the action. The CFTC filed a parallel action against Mr. Allensworth, David Weddle and others. See Lit. Rel. No. 23967 (Oct. 12, 2017).
Financial fraud: SEC v. de Nicolas, Civil Action No. 1:17-civ-2086 (S.D. Cal. Filed Oct. 11, 2017). The action names as defendants are: Gerardo de Nicolas Gutierrez, CEO of Desarrolladora Homex, S.A.B. de T.C.V.; Carlos Javier Monctezuma Velasco, CFO; Bamon Lafarga Batiz, controller and administrative and accounting officer; and Noe Corrales Reyes, manager in the operations department. Each defendant is a resident of Mexico. Homex, based in Culiacan, Sinaloa, Mexico, was at one time known as Mexico’s largest home builder. The firm specialized in constructing affordable, middle-class homes in Mexico. Its ADRs were listed for trading on the NYSE from 2004 through 2014. Its shares were also listed on the Mexican Stock Exchange or BMV. Beginning in 2010 false manual entries for home sales and the related revenues and expenses were entered into the system. This materially inflated the financial results of the firm. The fraudulent entries were tracked on manually created spreadsheets prepared by Mr. Lafargat at the direction of Mr. Corrales. Key to maintaining the fraud was the creation of cash flow, generated from fictitious receivables. When Homex built and sold a home the purchase price was typically financed by a mortgage from one of two large Mexican Government-backed lending institutions. Homex usually received the loan proceeds from the lender within weeks. Defendants de Nicolas and Moctezuma caused the firm to enter into non-recourse factoring agreements with a group of at least thirteen banks to monetize its receivables. Since the sales were largely false, the factoring agreements were also false, although they were certified by the CEO and CFO of the company. All of the false financial information was reflected in filings made with the Commission and certified by the CEO and CFO. Eventually the firm tumbled into the Mexican equivalent of bankruptcy. Its CEO and CFO resigned; its shares were delisted but continue to be quoted on OTC Link. Shareholder value was essentially wiped out. The complaint alleges violations of Securities Act Section 17(a) and Exchange Act Sections 10(b), 13(a), 13(b)(2)(A), 13(b)(2)(B) and 13(b)(5). The case is pending. See Lit. Rel. No. 23964 (Oct. 11, 2017). The company previously settled with the Commission.
Blank check companies: SEC v. Schneider, Civil Action No. 9:17-cv-81142 (S.D. Fla. Filed Oct 11, 2017) is an action against attorney James Schneider. The complaint alleges that Mr. Schneider facilitated the sale of at least 20 undisclosed blank check companies between 2008 and 2013. In connection with these transactions he acted as incorporator, prepared opinion letters with respect to the valid issuance and unrestricted nature of the securities involved and filed false applications with FINRA. He distributed at least $5.6 million in proceeds from the sale of 17 of the companies at the direction of the Control Persons. The complaint alleges violations of Securities Act Sections 5(a), 5(c) and each subsection of Section 17(a) and Exchange Act Section 10(b). The case is pending. See also SEC v. Wilson, Civil Action No 17-cv-23712 (S.D. Fla. Filed Oct. 11, 2017)(action against attorney Andrew Wilson based on facts cited above). See Lit. Rel. No. 23965 (Oct. 11, 2017).
Offering fraud: SEC v. Bershan, Civil Action No. 1:17-cv-07793 (S.D.N.Y. Filed Oct. 11, 2017) is an action which names as defendants Lisa Bershan, the CEO and founder of Starship Snacks, Corp.; Barry Schwartz, Ms. Bershan’s husband and an affiliate of Starship; and Joel Margulies, a principal of Starship. Over a two year period beginning in August 2015 defendants raised over $2.2 million from about 35 investors who acquired shares of Starship. Investors were told that the firm was developing a caffeinated chocolate snack. The shares of the firm were supposedly going to be acquired first by Monster Energy Company and later The Coca Cola Company. They were also guaranteed against lost and told that the shares could be redeemed at any time at a 5% premium. In fact the representations were false. Defendants misappropriated the funds. The complaint alleges violations of Securities Act Section 17(a) and Exchange Act Section 10(b). The case is pending. The Manhattan U.S. Attorney’s Office filed a parallel criminal case.
Offering fraud: SEC v. Celello, Civil Action No. 1:17-cv-03903 (N.D. Ga. Filed Oct. 5, 2017) is an action which names as a defendant Marc Celello, an attorney admitted to practice in the state of Georgia. He has served as the general counsel of CN Capital since its inception. His services were terminated by a receiver appointed in SEC v. Torchia, Civil Action No. 1:15-cv-03904 (N.D. Ga.). He has also worked for other entities controlled by James Torchia, the principle of CN Capital. Mr. Torchia settled the Commission’s action, consenting to the entry of a permanent injunction. Remedies are to be resolved at a later date. Between 2009 and 2015 when the court halted its operations, CN Capital raised millions of dollars from investors through the sale of unregistered promissory notes which promised a 9% return. In fact the company was a Ponzi scheme. Mr. Celello is alleged to have been an active participant in the fraud. He prepared the offering memoranda and was the interface with the sales and marketing representations who claimed that the notes were 100% asset backed dollar for dollar when in fact they were not. He also knew that the firm’s assets were dwarfed by its liabilities. The complaint alleges violations of each subsection of Securities Act Section 17(a) and Exchange Act Section 10(b). The case is pending. See Lit. Rel. No. 23962 (Oct. 6, 2017).
Remarks: Ashley Adler, CEO of the Securities and Futures Commission, delivered the Keynote speech at the 8th Pan Asian Regulatory Summit (Oct. 10, 2017). His remarks focused on the relationship of Hong Kong to the mainland and the larger role he sees for the exchange in international transactions in the future (here).