This Week In Securities Litigation (Week ending October 2, 2014)
As the government fiscal year drew to a close, the SEC continued what appears to be an emerging trend of filing insider trading actions as administrative proceedings rather than civil injunctive actions in Federal Court. The Manhattan U.S. Attorney’s Office also got back on track, prevailing in a 13 day insider trading trial.
In addition to insider trading actions, the Commission brought cases relating to offering fraud; investment fund fraud; undisclosed conflicts; regulatory capital stemming from the market crisis; and failure to supervise.
Remarks: Chair Mary Jo White delivered remarks titled “The Challenge of Coverage, Accountability and Deterrence in Global Enforcement at the IOSCO 39th Annual Conference, Rio de Janiero (Oct. 1, 2014). Her remarks provided an overview of the enforcement division and efforts regarding international cooperation (here).
Remarks: Commissioner Michael S. Piwowar delivered remarks at the National Association of Plan Advisors D.C. Fly-In Forum (Sept. 30, 2014). His remarks centered on the standard of care for those who provide investment advice to retail investors (here).
Remarks: Mark J. Flannery, Chief Economist and Director, delivered remarks titled “The Commission’s Production and Use of Structured Data” at the Data Transparency Coalition’s Fall Policy Conference, Washington, D.C. (September 30, 2014). His remarks focused on the efforts of the Commission to make financial data available (here).
SEC Enforcement – Filed and Settled Actions
Statistics: This week the SEC filed 7 civil injunctive action and 7 administrative proceedings, excluding 12j and tag-along-actions.
Offering fraud: In the Matter of Paul Edward “Ed” Lloyd, Jr., CPA, Adm. Proc. File No. 3-16182 (September 30, 2014) is a proceeding against Mr. Lloyd who is a tax preparer and has been a registered representative. In 2012 Mr. Lloyd sold interests to seventeen clients in what was supposed to be a tax advantaged real estate deal, raising about $632, 500. However, he only put $502,500 in the entity, misappropriating the remaining funds from three investors. Nevertheless, when he secured tax benefits for the deal they were allocated to seventeen clients. He sent the pertinent tax forms to the three investors whose money he had misappropriated. The Order alleges violations of Exchange Act Section 10(b) and Advisers Act Sections 206(1), 206(2) and 206(4). The proceeding will be set for hearing.
Investment fund fraud: SEC v. Abdallah, Civil Action No. 1:14-cv-01155 (N.D. Ohio Filed September 30, 2014) is an action which names as defendants Thomas Abdallah, Kenneth Grant, KGTA Petroleum Ltd., Mark George, Jeffrey Gainer and Jerry Cicolani. Shares of KGTA were sold to the public by Messrs. Grant and Abdallah as interests in a firm that had earnings from buying and reselling crude oil and refined fuel products. The representations were false. In fact the operation was a Ponzi scheme. The investor funds were supposedly safeguarded by attorney Mark George who would act as an escrow agent. Mr. George never instituted the appropriate procedures. Defendants Gainer and Cicolani are registered representatives who aided the distribution. The complaint alleges violations of each subsection of Securities Act Section 17(a) and Exchange Act Sections 10(b) and 15(a)(1). The case is pending. See Lit. Rel. No. 23097 (September 30, 2014).
Misappropriation: SEC v. Wright, Civil Action No. 1:14-cv-01896 (M.D. Pa. Filed September 30, 2014) is an action against former registered representative Dennis Wright. He defrauded about 28 customers out of $1.5 million by convincing them to redeem securities in their accounts by falsely claiming he would reinvest the funds and obtain a higher yield. Instead he misappropriated the money. The complaint alleges violations of Securities Act Section 17(a) and Exchange Act Section 10(b). Parallel criminal charges were also brought. Mr. Wright settled with the SEC by consenting to the entry of a permanent injunction based on the Sections cited in the complaint. He also agreed to pay disgorgement, which will be deemed satisfied by the entry of a restitution order, and to be barred from the securities business and from participating in any penny stock offering. See Lit. Rel. No. 23100 (September 30, 2014).
Undisclosed conflicts: SEC v. Wealth Strategy Partners, LC, Civil Action No. 14-cv-02427 (Filed September 25, 2014) is an action which names as defendants: the firm and its principal, Harvey Altholtz; and Stevens Resource Group, LLC and its principal, George Stevens as defendants. The complaint alleges that the defendants engaged in two fraudulent offerings of securities for two investment funds, raising $30.8 million from over 143 investors between 2007 and 2009. Investors were not told that for one fund its assets could be used to guarantee certain loans of the Altholtz family and that the family made loans to both managed funds in violation of their operating agreements. Defendants Wealth Strategy and Altholtz also gave the Altholtz family trust, an investor in one fund, preferential treatment regarding redemptions over other investors. The complaint alleges violations of Securities Act Section 17(a), Exchange Act Section 10(b) and Advisers Act Sections 206(d). The case is pending. See Lit. Rel. No. 23098 (September 30, 2014).
Insider trading: In the Matter of Filip Szymik, Adm. Proc. File No. 3-16183 (September 30, 2014); In the Matter of Jordan Peixoto, Adm. Proc. File No. 3-16184 (September 30, 2014). Filip Szymik’ roommate and boyhood friend is an Analyst at Pershing Square Management, L.P, a hedge fund lead by well-known activist investor William Ackman. Beginning in September 2012 he was part of an investment team assigned to research Herbalife. Though that position he learned that Pershing had concluded the company was an illegal pyramid scheme, a position it planned to disclose at a conference on December 20, 2012. Prior to December 19, 2012 the Analyst disclosed to his friend and roommate that he was working on Herbalife. He also told Mr. Szymik that the firm had a negative view which would be disclosed on December 20. One of Mr. Szymik’s close friends is Jordan Peixoto, a research analyst at Deloitte. Prior to December 19, 2012 Mr. Szymik told his friend about Herbalife, the position of Pershing Square and the pending presentation. Mr. Peixoto knew that his friend’s roommate was an analyst at Pershing Square and that the work was confidential. Nevertheless, just before 2:00 p.m. on December 19, 2012 he purchased Herbalife options. Shortly after those purchases, CNBC reported that Pershing had acquired a significant short position in Herbalife and was making a presentation the next day. Following the CNBC report, and the Pershing presentation on December 20, 2012, Herbalife stock declined by 39%. By the close of the market on December 21 Mr. Peixoto’s options had increased in value to about $339,421. He asked his brokers to let them expire worthless. One refused, giving him a profit of $47,100. Each Order alleges violations of Exchange Act Section 10(b). Mr. Szymik settled with the Commission, consenting to the entry of a cease and desist order based on the Section cited in the Order. He also agreed to pay a civil penalty of $47,100. Mr. Peizoto did not resolve his action. It will be set for hearing.
Insider trading: In the Matter of George T. Bolan, Jr., Adm. Proc. File No. 3-16178 (September 29, 2014). George Bolan was a research analyst in health care at Wells Fargo. Respondent Joseph Ruggieri was a senior trader of health care stocks in Wells Fargo’s trading department in New York from August 2009 to April 2011. He was also a registered representative, executing customer transactions and placing principal trades on behalf of Wells Fargo. Messrs. Bolan and Ruggieri are friends. Mr. Bolan was a well-respected analyst in the areas he covered. Institutional Investor publications named him “Best up and Comer” in 2010. Between April 2010 and March 2011 Mr. Bolan published eight ratings changes or initiations of coverage with an outperform or underperform rating. Mr. Ruggieri traded in advance of six of them, according to the Order. In each instance the Order alleges that the Mr. Bolan, after completing his assessment of the firm, and before the publication of the report, “communicated, in words or substance, material nonpublic information . . .” to Mr. Ruggieri. In some instances the Order alleges that after Mr. Bohan’s supervisor signed off on the report there was a phone call between the two men. In each instance Mr. Ruggieri traded in advance of the public distribution of the report. Following the publication of the six reports the volume and/or the stock price increased or decreased, depending on the rating. Overall Mr. Ruggieri had over $117,000 in trading profits. Mr. Bolan is alleged to have benefited from the illegal tipping because of the friendship between the two men and from the recommendation that assisted him in obtaining a promotion. In addition, Order alleges that Mr. Bolan tipped Trader A in one instance in May 2010 who traded profitably. Trader A was a friend of Mr. Bolan who has since passed away. The Order alleges violations of Securities Act Section 17(a) and Exchange Act Section 10(b). The proceeding will be set for hearing.
Investment fund fraud: SEC v. Mathe (S.D. Fla. Filed September 29, 2014) is an action against Erick Mathe and Ashif Jiwa. Mr. Mathe was the CEO and largest shareholder of Vision Broadcast. Mr. Jiwa was employed by the company as a consultant. Over a period of three years beginning in August 2007 the two men sold interest in the firm to about 100 investors, raising about $5.7 million. The firm was supposed to be an early-stage operational start-up television network and production company. Investors were told that Michael Jordan was going to invest in the firm and that a large institutional investor was also putting in funds. In fact those statements and others were misrepresentations. Much of the investor money went to the defendants. The complaint alleges violations of Securities Act Sections 5(a) and 5(c) and each subsection of Section 17(a) and Exchange Act Section 10(b). The case is pending. A parallel criminal case was brought by the U.S. Attorney’s Office for the Eastern District of Pennsylvania. See Lit. Rel. No. 23094 (September 29, 2014).
Failure to supervise: In the Matter of Rothman Securities, Inc., Adm. Proc. File No. 3-16180 (September 29, 2014) is a proceeding which names as Respondents the firm, a registered broker-dealer, and its founder, owner, president and director of the firm, Theodore Rothman. From 2006 through 2011 Mr. Rothman’s son David, while working at the firm, issued false account statements to several clients. When the fraud was discovered David tried to conceal the activity by paying the investors himself. When he could no longer do so, he misappropriated money from two firm client trust accounts. David pleaded guilty to criminal charges and is a defendant in an SEC enforcement action based on that activity. This action is for failure to supervise David. It alleges that several red flags were missed during the period and that Mr. Rothman failed to review incoming and outgoing correspondence and periodically review account statements as required by firm procedures. If he had reviewed customer account statements and cover letters to customers regarding their account values the misrepresentations to customers regarding account values and the subsequent misappropriation the fraud would have been detected. The Order alleges violations of Exchange Act Section 15(b). To resolve the proceeding the firm consented to the entry of a censure while Mr. Rothman consented to the entry of an order barring him from serving in a supervisory capacity in the securities business. He also agreed to pay a civil penalty of $40,000.
Financial fraud: SEC v. China Valves Technology, Inc., Civil Action No. 1:14-cv-01630 (D. D.C. Filed September 29, 2014) is an action against the company, its Chairman and former CEO, Siping Fang, its former CEO, Jianbao Wang and its CFO, Renrui, Tang. The complaint alleges two schemes which resulted in falsifying the books. The first involves the acquisition of a firm which had been involved in an FCPA investigation. To conceal that fact and payments made, certain facts regarding the acquisition were concealed. Second, to conceal the fact that a product was acquired to reverse engineer, and because of intellectual property concerns, the payments for it were intentionally disguised. The complaint alleges violations of Exchange Act Sections 10(b), as well as Sections 13(a), 13(b)(2)(A) and 13(b)(2)(B). An order was also issued in a related administrative proceeding to determine if the firm’s registration should be revoked. The case is pending. See Lit. Rel. No. 23096 (September 29, 2014).
Investment fund fraud: SEC v. Ferguson, Civil Action No. 3:14-cv-04188 (N.D. Cal. Filed September 29, 2014) is an action against Michael Ferguson and his company, Transactions Unlimited. The defendants did business as ATM Plus. Since 2005 they solicited investors for the business which operated ATM machines. It claimed to have lucrative agreements to brand ATMs for several major distributors. Over the period of the scheme at least $12 million was raised from about 160 investors. Representations regarding the business and its success were false. Larger sums were repaid to investors than the business made – that is, investor funds were used to pay other investors. The complaint alleges violations of the antifraud and registration provisions. The case is pending. A parallel action was filed by the Santa Clara County District Attorney’s Office. See Lit. Rel. No. 23095 (September 29, 2014).
Regulatory capital: In the Matter of Bank of America Corporation, Adm. Proc. File No. 3-16177 (September 29, 2014) is a proceeding in which Bank of America was charged with violations of Exchange Act Sections 13(b)(2)(A) and 13(b)(2)(B). Those violations are the result of not properly calculating its regulatory capital since 2009. In the acquisition of Merrill in 2009 the Bank acquired Notes with a par value of $52.5 billion. The notes had a fair value at the time which was below par stemming from a decline in Merrill’s creditworthiness. Thus, in accord with GAAP, Bank of America booked the notes at fair value which was a $5.9 billion discount to par. At the same time the Bank assumed the liability at par. In calculating regulatory capital Bank of America was required to include the realized losses that were recognized in GAAP equity. Yet in calculating regulatory capital from the time of the acquisition until 2013, the Bank failed to include the losses. As more notes matured, or were repurchased by Bank of America, additional losses resulted. Failing to book those losses resulted in overstatements of its regulatory capital. During the period 15 Form 10-Qs contained an overstatement of regulatory capital. In addition, 5 Form 10-K Filings contained overstatements. In April 2014 the Bank discovered the flaw in its process and issued a press release announcing a downward revision to its disclosed regulatory capital amounts and rations. A Form 8-K was also filed. The firm self-reported, instituted remedial steps and developed improved documentation and spreadsheet controls and enhanced internal controls. Bank of America resolved the proceeding, consenting to the entry of a cease and desist order based on the Sections cited in the Order. It also agreed to pay a civil penalty of $7,650,000.
Investment fund fraud: In the Matter of Kenneth C. Meissner, Adm. Proc. File No. 3-16175 (September 25, 2014) is a proceeding which names as Respondents Mr. Meissner, James Scott and Mark Tomich – three insurance brokers. This proceeding centers on a fraudulent investment scheme run by Gary Snisky from mid-2011 through early 2013. During that period $4.3 million was raised from 40 investors in eight states by selling memberships in Arete, LLC and other controlled entities. Mr. Snisky recruited insurance agents to solicit prospective investors who were promised no-risk, profitable alternatives to traditional annuities by offering interests in government agency bonds. In fact Mr. Snisky never invested in any bonds. Rather, he misappropriated the funds. The Respondents here acted as salesmen for Mr. Snisky. They sold securities without being registered brokers in violation of Exchange Act Section 15(a). The action will be set for hearing.
Investment fund fraud: SEC v. eAGear, Inc. Civil Action No. 14-cv-04294 (N.D. Cal. Filed September 24, 2014) is an action in which the defendants are eAdGear, an internet company; eAdGgear Holdins Ltd.; Charles S. Wang; Francis Yuen; and Qian Cathy Zhang. Mr. Wang is the founder and CEO of eAdGear Holdings, Mr. Yuen is the founder and CFO and COO of eAdGear Holdings and eAdGear; Ms. Zhang is a defacto officer of both companies. eAdGear is represented to be a successful internet marketing and advertising company. The firm supposedly increases page rankings for customer websites on search engines. Investors have the opportunity to profit in two ways. First, each investor account is credited daily with a share of the revenues generated from the collective efforts of the members. Second, investors are credited with a portion of the money generated from the referral of new investors who purchase a package for a fee. Investors are told that they have the potential for very significant returns. The defendants have sold investors about $129 million in so-called memberships or business packages in eAdGear.com over the last four years. Although eAdGear claims to generate millions of dollars in revenues from its internet marketing business, in fact it has no such business, according to the complaint. Revenue was generated from the sale of memberships and then misappropriated by the defendants. eAdGear is tottering on the brink of collapse. The Commission’s complaint alleges violations of Securities Act Section 17(a), Exchange Act Section 10(b) and liability under Exchange Act Section 20(a). The case is pending.
Insider trading: U.S. v. Riley, No. 1:13-cr-00339 (S.D.N.Y.) is an action against David Riley, the former Chief Information Officer of Foundry Networks, Inc. Following a 13 day trial he was found guilty on one count of conspiracy and two counts of securities fraud tied to a $27 million insider trading scheme. The case centered on tips related to foundry’s acquisition by Brocade Communications and the firm’s first quarter 2008 earnings that were furnished to Matthew Teeple, a former analyst for hedge fund Artis Capital Management, L.P. Sentencing is scheduled for February 6, 2015.