This Week In Securities Litigation (Week ending Sept. 23, 2016)
The Commission filed its first action against an auditor for lack of independence based on a romantic relationship this week. The agency also filed an action alleging insider trading against long time hedge fund operator, Leon Cooerman and another insider trading case against a couple, each of whom work at a different financial advisory service. In addition, a settled FCPA action was filed.
SEC Enforcement – Filed and Settled Actions
Statistics: During this period the SEC filed 2 civil injunctive action and 14 administrative proceeding, excluding 12j and tag-along proceedings.
Insider trading: SEC v. Whelehan, Civil Action No. 23652 (S.D.N.Y. Filed Sept 22, 2016) is an action which names as defendants Colin Whelehan and Sheren Tsai. Each defendant was employed at an investment advisory firm. Ms. Tsai traded in the shares of ADT before it was acquired. Her boyfriend, defendant Whelehan, obtained the information about the deal through his firm. Following the deal announcement Ms. Tsai had trading profits of about $19,500 while a relative she tipped who traded had profits of $4,414.41. The complaint alleged violations of Exchange Act Section 10(b). To revolve the case each defendant consented to the entry of a permanent injunction prohibiting future violations of the Section cited in the complaint. In addition, Mr. Whelehan will pay a penalty of $23,914.42. Ms. Tsai will pay disgorgement of $23,914.41 along with prejudgment interest and a penalty equal to the amount of the disgorgement.
Insider trade: SEC v. Khan, Civil Action No. 3:14-cv-02743 (N.D. Cal. Filed June 13, 2016) is a previously filed action against Saleem Khan and Roshanial Chaganial. The complaint alleged that Mr. Chaganial, an employee at Ross headquarters, repeatedly furnished his friend with inside information. Mr. Kham traded. The two men agreed to settle with the Commission, consenting to the entry of permanent injunctions prohibiting future violations of Exchange Act Section 10(b). Mr. Khan agreed to pay disgorgement of $7493,000 and prejudgment interest along with a penalty equal to the amount of the disgorgement. Mr. Chaganial will pay disgorgement of $130,000, prejudgment interest and a penalty equal to the amount of the disgorgement. See Lit. Rel. No. 23649 (Sept. 21, 2016). See Lit. Rel. No. 23652 (Sept. 22, 2016).
Insider trading: SEC v. Cooperman (E.D. Pa. Filed Sept. 21, 2016). The case centers on trading in the securities of Atlas Pipeline Partners, L.P. or APL by defendant Omega Advisors, Inc., a registered investment adviser controlled by Leon Cooperman. The firm furnishes advice to Omega’s hedge funds and other institutional accounts. The trading took place prior to the announcement on July 28, 2010 by APL that it had entered into an agreement to sell its Elk City operating facilities to Enbridge Energy Partners, L.C. In mid-May 2010 Enbridge made an offer to purchase Elk City for $720 million. Mr. Cooperman, who has been a hedge fund manager for years, was the beneficial owner of over 9% of APL common stock as of December 31, 2009. This gave Mr. Cooperman a significant level of access to the firm – a technique he had used in the past. Through the first half of the year he reduced his stake in APL, directing controlled accounts to sell millions of dollars in stock. On July 7, 19 and 20 Mr. Cooperman spoke with APL Executive I on the telephone. He learned that the firm was negotiating the sale of Elk City for about $650 million. On July 7 a Cooperman account began buying APL call options. Additional purchases of APL securities were made on July 8, 13, 15, 16, 19, 20, 21, 22, 26 and 27. During the buying Mr. Cooperman again spoke with APL Executive I. Following the deal announcement defendants had over $4 million in trading profits. Subsequently, Mr. Cooperman attempted a cover-up. The complaint also asserts that Mr. Cooperman violated the beneficial ownership reporting provisions of the securities laws over a period of years. The complaint alleges violations of Exchange Act Sections 10(b), 13(d) and 16(a). The case is pending. The U.S. Attorney’s Office reportedly is awaiting the decision in Salman.
Blank check companies: In the Matter of Sheldon Rose, Adm. Proc. File No. 3-17559 (Sept. 21, 2016) is a proceeding which names as Respondents Mr. Rose, and his alter ego, MKJJ Consulting LLC. Respondents control 17 blank check companies. They have sold 15, following a basic blueprint to create public companies, register offerings of securities and not disclose the true purpose of the firm or who controls it. The Order alleges violations of Securities Act Section 17(a) and Exchange Act Sections 10(b), 13(b)(2)(A), 13(b)(2)(B), 13(b)(5) and 15(d). To resolve the proceedings Respondents each consented to the entry of a cease and desist orders based on the Sections cited in the Order. They are also barred from participating in any penny stock offering and Mr. Rose is barred from serving as an officer or director of any public company. Respondents will pay disgorgement, prejudgment interest and civil penalties in amounts to be determined later.
Valuation: In the Matter of Park National Corporation, Adm. Proc. File No. 3-17561 (Sept. 21, 2016) is a proceeding which names the firm, a bank holding company, as a Respondent. In 2010 and 2011 the firm improperly valued certain impaired loans for its Allowance for Loan Losses by improperly incorporating into the analysis certain cash flows anticipated from guarantors. Yet the firm was in litigation with most of those guarantors. It also used improper collateral valuations. In 2012 the firm restated its financial statements for fiscal 2010 and the first three quarters of 2011. The Order alleges violations of Exchange Act Sections 13(a), 13(b)(2)(A) and 13(b)(2)(B). To resolve the matter the firm consented to the entry of a cease and desist order based on the Sections cited in the Order. It also agreed to pay a penalty of $500,000.
Unregistered broker: In the Matter of 3C Advisors & Associates, Inc., Adm. Proc. File No. 3-17070 (Sept. 19, 2016) is a proceeding which names as Respondents the firm, which provides a range of capital advisory services, and Stephen Ones and David Prolman, two of its senior officials. The Order alleges that over a two year period beginning in 2013 the Respondents provided a range of service to small and medium business which it marketed as capital advisory services that included arraigning private placements of debt and equity securities and facilitating capital raises. The fees were calculated as a percentage of the capital raised. The Order alleges violations of Exchange Act Section 15(a). Mr. Prolman resolved the matter, consenting to the entry of a cease and desist order based on the Section cited in the Order. He is also suspended from the securities business and from participating in any penny stock offering for a period of twelve months. In addition, he will pay a fine of $7,500.
Net capital: In the Matter of Kenny Phu, Adm. Proc. File No. 3-17555 (Sept. 19, 2016) is a proceeding which names as a Respondent Mr. Phu, formerly a registered representative at now defunct broker, Crucible Capital, Inc. For a two year period beginning in February 2012 he is alleged to have aided and abetted the net capital violations of the firm. The Order alleges violations of Exchange Act Section 15(c)(3). To resolve the matter Respondent consented to the entry of a cease and desist order based on the Section cited in the Order. He is also barred from the securities business and from participating in any penny stock offering with a right to reapply after five years. In addition he will pay a penalty of $10,000.
Auditor independence: In the Matter of Ernst & Young LLP, Adm. Proc. File No. 3-17552 (Sept. 19, 2016) names as Respondents the audit firm and Gregory S. Bednar, CPA. Mr. Bednar served as the coordinating partner for a new EY engagement team for Client I after the firm had been terminated. The engagement team reported to him. While the engagement partner was responsible for the day-to-day engagement, Mr. Bednar had overall responsibility for the engagement and focused on the “relationship piece” with Client I. During 2012 – 2014 Mr. Bednar developed and maintained a close personal relationship with the CFO and members of his family. He spent extensive leisure time with the executive and his family. There were frequent out of town and overnight trips with the CFO and his family; overnight stays at his home; repeated social events and gifts; tickets to professional sports events for the CFO and his family; and other social contacts throughout the period. While other EY partners became aware of the close personal relationship, they failed to act. Firm policies at the time required audit engagement teams for public companies to comply with certain annual and quarterly procedures to assess the firm’s independence. They also required engagement team members to certify their independence. While the firm recognized that a close personal relationship could cause an independence issue, it never asked about such relationships. The individual certifications focused on possible employment relationships but not close personal relationships. Here Mr. Bednar lacked independence from Client I under Rule 2-01(b) of Regulation SX. EY also lacked independence and Mr. Bednar aided and abetted and caused the firm’s violations. In resolving the action EY undertook to improve its policies and procedures. The firm and Mr. Bednar also consented to the entry of cease and desist orders based on Rule 2-02(b) and Exchange Act Section 13(a). EY was censured and Mr. Bednar denied the privilege of appearing or practicing before the Commission as an accountant with the right to request reinstatement after three years. EY will also pay disgorgement of $3,562,400, prejudgment interest and a penalty of $1.2 million.
Auditor independence: In the Matter of Ernst & Young LLC, Adm. Proc. File No. 3-17553 (Sept. 19, 2016). In addition, to the audit firm, the proceeding names as Respondents Robert J. Brehl, CPA, Pamela J. Hartford, CPA and Michael T. Kamienski. Mr. Brehl served as chief accounting officer of public Client 2 while Ms. Hartford acted as the EY engagement partner and later the coordinating partner for Client 2. Mr. Kamienski served as the coordinating partner on the engagement from 2009 through 2013. EY served as outside auditor to Client 2 from 2004 through 2014. From March 2012 through June 2014, while Ms. Hartford served first as the engagement partner and later the coordinating partner, she and Mr. Brehl maintained a romantic relationship. That relationship was marked by a “high degree of personal intimacy, affection and friendship, near daily communications that were personal as well as work related and occasional exchanges of small gifts. While the two tried to secrete their relationship, they were unsuccessful. During the time he served as coordinating partner, Mr. Kamienski became aware of certain red flags but failed to properly follow-up. In June 2014 a firm vice president at Client 2 made an internal whistleblower complaint regarding a possible inappropriate relationship between Mr. Brehl and Ms. Hartford. The company conducted an internal investigation and reported its findings to EY. The audit firm removed Ms. Hartford from the engagement team, conducted its own investigation and eventually withdrew its audit reports issued on the 2012 and 2013 financial statements of the firm and other reports. To resolve the matter each Respondent consented to the entry of a cease and desist order based on Rule 2-02(b)(1) of Regulation S-X and Exchange Act Section 13(a) and Rule 13a-1. EY was censured while Respondents Hartford, Kamienski and Brehl were denied the privilege of appearing before the Commission as accountants. Respondents Hartford and Kamienski may apply for reinstatement after three years; Mr. Brehl may apply after one year. EY will also pay disgorgement of $3,168,500, prejudgment interest and a civil penalty of $1 million. Respondents Hartford and Brehil will each pay a civil penalty of $25,000. See also In the Matter of Robert A. Waegelein CPA, Adm. Proc. File No. 3-17562 (Sept. 21, 2016)(settled proceeding against CFO Respondent who maintained a close personal relationship with the coordinating partner for the engagement team for the firm’s outside auditors; settled with a consent to a cease and desist order based on Exchange Act Section 13(a) and the payment of a penalty of $25,000).
Offering fraud: In the Matter of Fusion Pharm, Inc., Adm. Proc. File No. 3-17545 (Sept. 16, 2016) is a proceeding against the firm which focuses on the development of a patented cultivation system used primarily to grow cannabis. The Order alleges that the firm, through its CEO Scott M. Dittman and its undisclosed de facto officer and control person William Sears, engaged in a $12.2 million fraudulent offering, selling unregistered shares, then recognizing the funds as revenue and hyping the stock through press releases and financial reports that were false. The Order alleges violations of Securities Act Section 5(a) and Exchange Act Section 10(b). It will be set for hearing. The Commission also filed a series of related actions. See In the Matter of Scott M. Dittman, CPA, Adm. Proc. File No. 3-17546 (Sept. 16, 2016)(founder of the firm); In the Matter of William J. Sears, Adm. Proc. File No. 3-17547 (Sept. 16, 2016)(de facto officer and control person); In the Matter of Microcap Management LLC, Adm. Proc. File No. 3-17548 (Sept. 16, 2016)(the firm, along with Bayside Realty Holdings LLC and Meadpoint Venture Partners, LLC, all firms tied to Sears); In the Matter of Cliffe R. Bodden, Adm. Proc. File No. 3-17549 (Sept. 16, 2016)(participated in the offering but is currently in prison); and In the Matter of Tod A. Ditommaso, Esq., Adm. Proc. File No. 3-17550 (Sept. 16, 2016)(attorney admitted in California). Each action is based on similar facts to those alleged in the order involving the company and asserts similar charges. Each will be set for hearing.
In the Matter of Nu Skin Enterprises, Inc., Adm. Proc. File No. 3-17556 (Sept. 20, 2016). Nu Skin Enterprises manufactures and markets cosmetic and nutritional products largely through direct selling or multi-level marketing. Its wholly owned subsidiary, Nu Skin (China) Daily Use & Health Products Co. Ltd., is based in Shanghai, China. The Direct Selling Laws in China prohibit the direct selling, multi-level commission structure used by the firm in the United States. The Direct Selling Laws provide that before a business such as Nu Skin China can operate, the firm must receive direct selling licenses at the national, provincial and city level.
In 2013 Nu Skin China held an unauthorized promotional meeting in a city despite the fact that it did not have a store or a direct selling license. Representatives of the Administration of Industry and Commerce for the province discovered the meeting and opened an investigation. Nu Skin China was subsequently informed that the agency had enough evidence to establish unauthorized activity and impose a fine. To avoid this employees contacted a Party Official and subsequently made a donation to a charity he selected. Although the parent company recommended that the subsidiary retain U.S. counsel regarding possible FCPA violations regarding the donation which it did, the anticorruption provisions the firm suggested be inserted in the papers with the charity were dropped from the final draft. The parent did not review that draft. Following the donation the investigation was dropped. The parent failed to have adequate procedures, according to the Order, given the high risk nature of the country. The Order alleges violations of Exchange Act Sections 13(b)(2)(A) and 13(b)(2)(B). The firm resolved the matter, consenting to the entry of a cease and desist order based on the Sections cited in the Order. It also agreed to pay disgorgement in the amount of $431,088 – the amount of the fine the agency would have imposed – prejudgment interest and a penalty of $300,000.
Investment fund fraud: U.S. v. Vaughn (E.D. Va.) is an action charging Sherman Vaughn and his confederate Merrill Robertson. Since 2009 the two men have raised about $9 million from over 50 investors. They convinced investors that they were experienced and worked with other experienced investment professionals. Much of the money was spent by the defendants. Mr. Vaughn pleaded guilty and is awaiting sentencing.
Investment fraud: U.S. v. Seltzer (N.D. Cal.) is an action which charged former securities lawyer James Seltzer with multiple counts of securities fraud and money laundering. Beginning in late 2007 and continuing through early 2011 Mr. Seitzer raised over $2.5 million from at least ten investors. He told investors their money would only be used for their benefit when in fact he diverted it to his own use. He pleaded guilty to one count of securities fraud and is awaiting sentencing.
Disclosure: A notice of infringement was issued as to Sanhe Building Materials. The firm announced its financial results for the year on February 3, 2016. The results for the full year were down 34% and that net profits after tax were down 67%. The notice is for failing to disclosure inside information. The firm paid a penalty of $33,000.
Program: The Dorsey Private Funds Symposium, Sept. 28 2016, New York City. For further information click here.