This Week In Securities Litigation (Week ending Sept. 30, 2016)
As the government fiscal year draws to an end, the Commission filed a series of enforcement actions. Those included two insider trading cases, an action alleging violations of the whistleblower provisions, another against a community bank tied to allegations about the valuation of its loan reserves, a financial fraud case against Weatherford International tied to its tax avoidance efforts and a market access proceeding against Merrill Lynch.
The SEC also filed two FCPA actions. Once was brought against a hedge fund Och-Ziff tied to is actions in certain African countries. The proceeding stems from the Commission’s investigation of sovereign wealth funds. A second focuses on the Indian subsidiary of beer giant Anheusar Busch.
Proposed rule: The Commission proposed a rule amendment to shorten the settlement process for securities transactions from three days to two (here).
Final rule: The Commission adopted rules to enhance the regulatory framework for securities clearing agencies that are deemed systemically important or that are involved in complex transactions such as security based swaps (here).
SEC Enforcement – Filed and Settled Actions
Statistics: During this period the SEC filed 7 civil injunctive action and 12 administrative proceeding, excluding 12j and tag-along proceedings.
Offering fraud: SEC v. Savva, Civil Action No. 16-cv-5432 (E.D.N.Y. Filed Sept. 29, 2016) is an action against Nicholas Savva. It centers on defrauding 12 investors in connection with his fund, Five Star Capital Fund, LP. The complaint alleges that Mr. Savva made misrepresentations about the firm’s management and its industry experience and historic performance in soliciting investments. A total of about $1.2 million was raised from investors. Defendant Savva misappropriated over $38,000 of the investors’ funds. The complaint alleges violations of Securities Act Section 17(a) and Exchange Act Section 10(b). Mr. Savva resolved the action, consenting to the entry of a permanent injunction based on the Sections cited in the complaint. He also agreed to pay disgorgement of $58,391.98, prejudgment interest and a penalty of $160,000. See Lit. Rel. No. 23661 (Sept. 29, 2016).
Whistleblowers: In the Matter of International Game Technology, Adm. Proc. File No. 3-17596 (Sept 29, 2016) is a proceeding which names as a Respondent the manufacturer of gaming equipment. An Employee of the firm responsible for evaluating the pricing methodology used at its parts division reported to the company and the Commission that the financial statements may be misstated because of its cost accounting model. An internal investigation was conducted. Investigators determined that the financial statements were correct. A few months later Employee was terminated. The Order alleges violations of Exchange Act Section 21F(h). To resolve the action the firm consented to the entry of a cease and desist order based on the Section cited in the order and agreed to pay a penalty of $500,000.
Insider trading: SEC v. Gadimian, Civil Action No. 1:16-cv-11955 (D. Mass. Filed Sept. 29, 2016). Defendant Robert Gadimian was employed by Puma Biotechnology, Inc. from November 2011 through October 2014. The firm was developing a drug for the treatment of breast cancer. In 2013 and 2014, Mr. Gadimian learned that the drug had reached key mile stones and, in advance of the announcements of trail results in each year, purchased company stock and options. In each instance he made the purchase in violation of firm policy during a blackout period. Overall he had trading profits of about $1.1 million. During an internal investigation at the firm, launched after hearing about some of Mr. Gadimian’s trading through a FINRA inquiry, Mr. Gadimian admitted to the transactions – after altering his brokerage records. The complaint alleges violations of Exchange Act Section 10(b). The case is pending. A parallel action criminal action was brought by the U.S. Attorney’s Office for the district of Massachusetts.
Insider trading: SEC v. Coppero, Civil Action No. 1:16-cv-07591 (S.D.N.Y. Filed Sept 28, 2016) is an action which names as defendants Nino Coppero Del Valle, an employee of HudBay Minerals, Inc. and a lawyer resident in Peru; Julio Antonio Castro, Mr. Coopero’s close friend and also a lawyer in Peru; and Richardo Carrion, Mr. Coopero’s acquaintance and a manager of a brokerage firm in Peru. The action centers on the February 9, 2014 announcement by HudBay that it would make a tender offer to acquire all the shares of Augusta Resource Corporation. After learning about the deal Mr. Coopero first tipped Defendant Castro; later he tipped Mr. Carrion. Subsequently, Messrs. Coopero and Castro traded together through the brokerage account of an off shore shell corporation. Mr. Carrion also traded. Following the deal announcement Messrs. Coopero and Castro had trading profit of over $73,000. The two men later tried to cover up their trading. The case is pending. See Lit. Rel. No. 23660 (Sept. 29, 2016).
Offering fraud: SEC v. Kohli, Civil Action No. 16-cv-5413 (E.D. Pa. Filed Sept. 28, 2016) is an action against Peter Kohli, DMS Advisors, Inc. and Marshad Capital Group, Inc. Mr. Kohli is the CEO of DMS, a registered investment adviser which advises DMS Funds; Marshad, controlled by Mr. Kohli, owns DMS. In 2012 Mr. Kohli launched DMS Funds. In the registration statement he falsely overstated the Funds’ sophistication and ignored key risks, including the fact that neither he nor DMS Advisors would be able to pay the expenses. Investors were told that Marshad had taken steps toward an IPO which was false. Mr. Kohli also misappropriated investor funds, using them to pay fund expenses. In addition, promissory notes were sold to investors despite the fact that there was no reasonable hope they could be honored. The complaint alleges violations of Securities Act Section 17(a), Exchange Act Section 10(b) and Advisers Act Sections 206(1), 206(2) and 206(4) and Investment Company Act Section 34(b). The court granted temporary relief. The case is pending. See Lit. Rel. No. 23659 (Sept. 28, 2016).
Supervision: In the Matter of UBS Financial Services Inc., Adm. Proc. File No. 3-17887 (Sept. 28, 2016) is a proceeding which names the registered broker-dealer and investment adviser subsidiary of UBS AG as a Respondent. Beginning in 2011, and continuing for the next three years, the firm sold a product called single stock-linked reverse convertible notes or RCN’s to its customers. The product is a complex structured note tied to single underlying stocks that had sufficient volatility to permit significant upside but limited downside risk and it had an imbedded derivative. Overall about $10.7 billion notional RCNs were sold. About $548 million of notional RCNs were sold to over 8,700 customers, many of whom had little relevant investment experience and modest reported net worth. Most of the sales were solicited. Yet the firm failed to adequately train its sales force regarding the product. Its supervisory policies were thus insufficient within the meaning of Exchange Act Section 15(b)(4)(E). The firm undertook unidentified remedial acts and cooperated with the Commission’s investigation. It consented to the entry of a censure. Respondent will also pay disgorgement of $8,227,566 along with prejudgment interest and a $6 million penalty.
Valuation: In the Matter of Orrstown Financial Services, Inc., Adm. Proc. File No. 3-17583 (Sept. 27, 2016). Orrstown is the holding company of Orrstown Bank, a Pennsylvania chartered bank. Respondents Thomas Quinn, Bradley Everly, Jeffrey Embly and Douglas Barton were, respectively, the CEO, CFO, Chief Credit/Risk Officer and CAO of the bank. In 2010 the firm had a loan policy which governed its review process. Loan reviews were to be performed by a Loan Review Officer, supervised by Mr. Embly and the firm’s Credit Administration Committee. The bank did not properly follow those policies. The key issue centers on three significant commercial lending relationships which involved the bank’s largest customers. Meetings were held with each customer. Messrs. Quinn, Everly and Embly attended the meetings. One customer had a total outstanding balance of about $28.8 million; a second had a balance of $12.2 million; the third had a balance of about $7.7 million. Each loan was impaired. The bank did not, however, disclose any of the loans as impaired. In addition, Orrstown did not disclose the value of other impaired loans in its quarterly filings for the periods ended June 30, 2010 and September 30, 2010. As a result there were violations of Securities Act Sections 17(a)(2) and (3) and Exchange Act Sections 13(a), 13(b)(2)(A) and 13(b)(2)(B). To resolve the action each Respondent consented to the entry of a cease and desist order based on the Sections cited in the Order except, the order as to Mr. Barton which was only based on the cited Exchange Act Sections. In addition, the bank will pay a penalty of $1 million; Messrs. Quin, Everly and Embly, will each pay $100,000 and Mr. Barton $25,000.
Financial fraud: In the Matter of Weatherford International PLC, Adm. Proc. File No. 3-17582 (Sept. 27, 2016). Weatherford is a multinational Irish public limited company based in Switzerland. Respondents James Hudgins and Darryl Kitay were, respectively, the firm’s V.P. of Tax and Tax Director. A key strategy of the firm was tax avoidance. To further that goal the firm did an inversion and Mr. Hudgins created a program of tax avoidance designed to reduce the effective tax rate of the firm. Weatherford reduced its effective tax rate nearly 10% from 2001 through 2006. That rate, however, was higher than its inverted peers. Subsequently, the firm began reporting results that suggested its strategy was outperforming that of others. In 2008 and 2009, for example, the firm reported a pre-tax effective tax rate of 17.1%. In each year from 2007 through 2010 Messrs. Hudgins and Kitay took steps to ensure that the reported effective tax rate was commiserate with their statements to analysts and shareholders touting their tax structure. Typically at year end the two men would calculate the actual rate. If the firm had not met the metric sought, they reversed legitimate financial entries, substituted plugs, and announced the false rate and related numbers as the firm’s actual results. This gave the firm plug tax benefits of over $150 million in 2007 and just over $100 million in 2008, 2009 and 2010. The firm never questioned the drop in the effective tax rate. The first restatement resulted from the discovery of Ernst & Young of certain discrepancies. The restatement reduced net income by $500 million. The remediation effort was led by Mr. Hudgins but was done improperly, yielding the second restatement at the end of September 2011. It resulted in an $84 million reduction from the firm’s previously reported net income to correct for the failure to accrue for certain withholding taxes prior to 2012. Mr. Hudgins resigned in March of the next year. Mr. Kitay was relieved of his duties. The third restatement resulted from a material error that a firm employee identified shortly before the second restatement was filed. The email went unanswered for over a month. As a result Weatherford failed to create a timely reserve for the item. Net income was reduced by $186 million, driven largely by the firm’s efforts to remediate its material weakness over internal controls related to accounting for income taxes. In February 2014 Weatherford announced it has successfully remediated its control weakness for accounting of income taxes. The Order alleges violations of each subsection 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 firm cooperated with the Commission’s investigation and agreed to implement a series of undertakings which include filing a report detailing its internal controls, policies and procedures over accounting for income taxes and conducting subsequent reviews. To resolve the action Weatherford consented to the entry of a cease and desist order based on each of the Sections cited in the Order except Exchange Act Section 13(b)(5). Messrs. Hudgins and Kitay also consented to the entry of cease and desist orders but based on each of the Sections cited in the Order. The firm will pay a penalty of $140 million. Mr. Hudgins is prohibited for a period of five years from acting as an officer or director of any issuer. Messrs. Hudgins and Kitay are each denied the privilege of appearing or practicing before the Commission as an accountant with the right to apply for reinstatement as an accountant after five years. Mr. Hudgins will pay disgorgement of $169,728, prejudgment interest and a penalty of $125,000. Mr. Kitay will pay a penalty of $30,000.
Financial fraud: SEC v. Hunter, Civil Action No. 2:16-cv-07246 (C.D. Cal.) is a previously file action against Keith Hunter, a former IT executive at the Commonwealth Bank of Australia. The complaint alleged that Mr. Hunter participated in a scheme to defraud Computer Sciences Corporation of about $98 million by accepting a bribe to have his employer enter into contracts with SCS in 2013 and 2014 so that CSC could receive an earn-out payment. To resolve the action Mr. Hunter consented to the entry of a permanent injunction based on Securities Act Section 17(a) and Exchange Act Section 10(b). In addition, he is barred from serving as an officer or director of any U.S. issuer and will pay disgorgement of $651,990 and prejudgment interest with credit for any amounts paid to the Australian and U.S. criminal authorities in the parallel actions. See Lit. Rel. No. 23657 (Sept. 27, 2016).
Market manipulation: SEC v. Wallace, Civil Action No. 8:16-cv-01788 (C.D. Cal. Filed Sept. 27, 2016) is an action which names as a defendant Jason Wallace. The complaint alleges that Mr. Wallace was retained by James Price, the owner of penny stocks. He was recruited as part of an effort to inflate the share prices of the stocks. Mr. Wallace operated a boiler room. Between September 2010 and January 2012 solicitations were made for four penny stock companies using cold calls to improperly inflate the share prices. About 8.3 million shares were involved generating $2.4 million in gross proceeds. The complaint alleges violations of Securities Act Sections 5(a), 5(c) and 17(a) and Exchange Act Sections 9(a)(2), 10(b) and 15(a). The case is pending. See Lit. Rel. No. 23656 (Sept. 27, 2016).
Market access: In the Matter of Merrill Lynch, Pierce, Fenner & Smith Inc., Adm. Proc. File No. 3-17573 (Sept. 26, 2016). To comply with the market access rule — Exchange Act Section 15(c)(3) and Rule 15c3-5 — Merrill Lynch determined that its orders would flow though four order controls known as a hard block. Orders of a certain size were blocked from market access. Many of the thresholds selected by senior managers of the business units were set at such high levels that the controls were ineffective. This resulted in numerous orders which should not have reached the market reaching it. Those orders at times caused the prices of the stock involved to fluctuate dramatically and disrupted the markets. Although Merrill Lynch conducted periodic reviews of its risk management controls under its procedures the firm concluded that they were functioning as expected. The reviews failed to consider if the high thresholds were effective. No adjustments were made. The Order alleges violations of Exchange Act Section 15(c)(3) and rule 15c3-5. To resolve the action the firm undertook remedial steps. Merrill Lynch also consented to the entry of a cease and desist order based on the Section and rule cited in the Order and a censure. The firm agreed to pay a penalty of $12.5 million.
Boiler room: SEC v. Sizer, Civil Action No. 1:16-cv-24106 (S.D. Fla. Filed Sept. 26, 2016) is an action which names as defendants Craig Sizer and Miguel Mesa. Mr. Sizer hired Miguel Mesa to operate a boiler room in South Florida and Southern California to sell shares of Sanomedics, Inc. and Fun Coo Free, Inc. Mr. Sizer provided pitch points for the salesmen and scripts. Mr. Mesa hired and supervised the boiler room agents in cold calls to sell the shares. Over a six year period beginning in 2009 investors were falsely told that the transactions were commission free. In fact commissions ranging from 15% to 20% were paid from investor funds. Investors were also falsely told that the funds raised would be used to conduct research and development and for the acquisition of another firm. In fact Mr. Sizer diverted at least $3 million of the proceeds to his personal benefit. To conceal the operation investors were told the callers worked for the companies. Mr. Mesa was not registered with the Commission as a broker. The complaint alleges violations of each subsection of Securities Act Section 17(a) and Exchange Act Sections 10(b) and 15(a). Each of the defendants resolved the action in part, consenting to the entry of permanent injunctions based on the Sections cited in the complaint. Other remedies will be considered at a later date on motion by the Commission.
Conflicts: In the Matter of Jan Gleisner, Adm. Proc. File No. 3-17588 (Sept. 28, 2016) is a proceeding which names as Respondents Mr. Gleisner and Keith Pagan. Mr. Gleisner is the managing director of Belvedere Asset Management LLC and owned 40% of Belvedere Tigers LLC which owned Belvedere. Mr. Pagan was the CEO of Belvedere. He owned 45% of Belvedere Tigers. From January 2013 through April 2014 Mr. Gleisner invested about one third of the assets held by Belvedere’s individual clients in the firm’s new mutual fund, Belvedere Alternative Income Fund. In doing so the firm and the Respondents failed to disclose to clients the material conflicts of interest which arose because of the ownership interests of each individual Respondent in the entities. The Order alleges violations of Advisers Act Sections 206(4) and 204(a). Respondents resolved the matter, consenting to the entry of cease and desist orders based on Advisers Act Section 206(2). The order as to Mr. Pagan is also based on the other Sections cited in the Order. Mr. Gleisner was censured. In addition, Mr. Gleisner will pay a penalty of $40,000. A penalty was not imposed on Mr. Pagan based on financial condition.
False pricing: In the Matter of Nicholas M. Bonacci, Adm. Proc. File No. 3-17575 (Sept. 26, 2016) is a proceeding naming Mr. Bonacci, formerly a registered representative at Morgan Stanley, as a Respondent. He was a trader on various securitized product desks. When trading mortgage-backed securities or RMBS he at times made misrepresentations to clients regarding the pricing. Specifically, during 2012 he misled clients regarding the price and the amount paid to Morgan Stanley. In some instances he falsely claimed to be arranging trades among parties when in fact he was selling out of inventory. Since the RMBS market is illiquid and opaque clients often rely on traders for accurate pricing information. The Order alleges violations of Exchange Act Section 15(c)(1)(A). To resolve the matter Mr. Bonacci consented to the entry of a cease and desist order based on the Section cited in the Order. He is suspended from the securities business for twelve months and will pay a civil penalty of $100,000.
Microcap fraud: SEC v. Medient Studios, Inc., Civil Action No. 4:16-cv-00253 (S.D. Ga. Filed Sept. 23, 2016) is an action which names as defendants the company, purported to be in the film business and which changed its name to Moon River Studios, Inc.; Fonu2, Inc., supposedly a social commerce company operating under the name Moon River Studios, Manu Kumaran who founded and served as CFO and CEO of Mediente International Films; Joel Shapiro, at one point the CEO and CFO of Medient; and Roger Miguel, ithe CEO of Fonu2. Beginning in late 2012 Medient claimed to be a movie and video game producer. The firm also claimed to be building the largest movie studio in North America. By early 2015 the building plan failed. The firm’s assets were transferred to Fonu2. The CEO of each firm at the time was Joel Shapiro. Fonu2 was doing business at the time as Moon River Studios. During the period billions of shares of Medient and Fonu2 were issued at a discount to third-party financing companies who dumped the shares. The filings of each company during the period contained a series of misrepresentations. The share sales were not registered or reported. Defendants benefited from the scheme, according to the complaint, by having the firms finance their lavish life styles. The complaint alleges violations of Securities Act Sections 5(a), 5(c) and 17(a) and Exchange Act Sections 10(b), 13(a) and 14(c). The case is pending. See also In the Matter of Charles A. Koppelman, Adm. Proc. File No. 3-17569 (Sept. 23, 2016) (alleging violations of Exchange Act Section 16(a) by Respondent who was on the board of Medient; resolved with a cease and desist order based on the Section cited and the payment of a $25,000 penalty); In the Matter of Matthew T. Mellon, II, Adm. Proc. File No. 3-17571 (Sept. 23, 2016)(Exchange Act Section 16(a) action against a Medient board member; the action will be set for hearing); In the Matter of David A. Paterson, Adm. Proc. File No. 3-17568 (Sept. 23, 2016)( Exchange Act Section 16(a) action against a Medient board member; resolved with consent to a cease and desist order based on the cited Section and the payment of a $25,000 penalty).
Prime bank fraud: SEC v. North Star Finance LLC, Civil Action No. 15-cv-1339 (Sept. 23, 2016) is a previously filed action alleging a prime bank fraud. Included as defendants are the firm, Thomas Ellis and Yasuo Oda, each of whom settled with the Commission. Each defendant consented to the entry of an injunction prohibiting future violations of Securities Act Sections 5(a), 5(c) and 17(a) and Exchange Act Sections 10(b) and 15(a). Other remedies will be considered at a later date on motion of the Commission. See Lit. Rel. No. 23653 (Sept. 23, 2016).
Och-Ziff Capital: Hedge Fund Och-Ziff Capital Management Group and its subsidiary, OZ Africa Management GP, LLC resolved FCPA charges with the DOJ and the SEC. In the criminal case the firm was charged in a four count criminal information. It alleged two counts of conspiracy to violate the FCPA, one count of falsifying its books and records and one count of failing to implement adequate internal controls. The firm’s subsidiary was charged with conspiring to bribe senior officials in the Democratic Republic of Congo. To resolve the charges Och-Ziff admitted the facts alleged in the complaint as part of entering into a three year deferred prosecution agreement that imposes a monitor. Och-Ziff will pay a criminal fine of $213 million. Subsidiary Oz Africa Management GP, LLC pleaded guilty to one count of conspiracy to violate the FCPA. Sentencing will be held on March 29, 2017.
The scheme centered on paying bribes in Libya, the DRC, Chad and Niger. Beginning in 2005, and continuing through 2012, a business man in the DRC paid over $100 million in bribes to officials for special access to certain investment. The hedge fund entered in several DRC related transactions with the businessman despite the fact that two firm employees knew – and a senior Och-Ziff employee believed – that it was likely the individual gained access to the investment through bribery.
Firm employees funded the ventures involving the businessman on the understanding that portions of the money would be used to pay high ranking DRC officials to secure, and to obtain, preferential treatment as to certain investment opportunities. In fact the businessman did pay bribes to secure the opportunities.
In 2007 a senior Och-Ziff employee engaged a third party arrangement to assist in securing an investment from the Libyan sovereign wealthy fund. When the agent was hired the company official knew corrupt payments would be required. No due diligence was conducted when the employee was retained. Following a meeting between a senior firm employee and a Libyan official empowered to make investment decisions for the sovereign wealth fund, a $300 million investment was made with Och-Ziff hedge funds. The firm subsequently entered into a consulting agreement under which $375 million was paid as a finder’s fee, knowing that a portion of that fee would be paid to Libyan officials.
In resolving the action the Department considered the fact that the firm failed to self-report and the high dollar nature of the transactions and that it cooperated during the investigation. The fine was set at 20% below the lower end of the sentencing guideline calculation.
The SEC brought a parallel action against the hedge fund, Oz Management L.P, a registered investment adviser, Daniel Och, its founder and CEO, and Joel Frank, its CFO. In the Matter of Och-Ziff Capital Management Group, Adm. Proc. File No. 3-17595 (Sept. 29, 2016). The conduct was discovered as part of the Commission’s investigation into dealings with sovereign wealth funds. The Order alleges violations of Exchange Act Sections 30A, 13(b)(2)(A), 13(b)(2)(B) and Advisers Act Sections 206(1), 206(2) and 206(4). To resolve the matter the two entity defendants agreed to implement a series of undertakings which include enhancing the internal controls and designating a CCO. The firm and Respondent Frank consented to the entry of a cease and desist order based on the Exchange Act Sections; Oz Management consented to a cease and desist order based on the Advisers Act Section; and Respondent Och consented to a cease and desist order based on Exchange Act Section 13(b)(2)(A). The two entities were also censured and will pay, jointly and severally, disgorgement of $173,186 and prejudgment interest. Respondent Och will pay disgorgement of $1,900,000 which represents his estimated gain from certain transactions and prejudgment interest.
In the Matter of Anheuser-Busch InBev SA/NV, Adm. Proc. File No. 3-17586 (Sept. 28, 2016) is a proceeding against the Belgian firm, a global brewer formed from the merger of Anheuser-Busch Companies Inc. and InBev SA/NV. Its wholly owned subsidiary, Crown Beers India Private Limited, operates in India. From 2009 through 2012 AB InBev held a 49% interest in an Indian joint venture that did the marketing for the firm. The Marketing firm used third party sales promoters to make improper payments to officials of the Indian government to obtain beer orders and increase brewery hours in 2011. The firm invoiced the subsidiary for reimbursement for certain of those expenses. They were paid. In doing so the Order alleges the firm had inadequate internal controls. The Order alleges violations of Exchange Act Sections 13(b)(2)(A) and 13(b)(2)(B). 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, it agreed to pay disgorgement of $2,712,955, prejudgment interest and a penalty of $3,002,955. The firm also agreed to certain undertakings.
Manipulation: U.S. v. Galanis, No. 1:15-cr-00643 (S.D.N.Y.). Gary Hirst was found guilty of conspiracy to commit securities and wire fraud relating to Gerova Financial Group, Ltd. He made about $2.6 million from the scheme. Mr. Hirst, along with his co-defendants — Jason, John, Jared and Derek Galanis and Ymer Shahini and Gavin Hamels — participated in a scheme to manipulate the shares of the company. Control was obtained over the shares of Gerova which was concealed. About 5 million shares were issues and a series of controlled accounts opened. Those accounts were then used to engage in manipulative trading and hold the proceeds from the transactions. Overall about $20 million in shares were sold from the accounts. The value of the remaining shares held by the public is now $0. Previously, Derek Galanis, Jason Galanis, John Galanis and Gavin Hamels pleaded guilty.