This Week In Securities Litigation (Week ending September 15, 2017)

The Commission filed another in a series of actions against an investment adviser who put wrap fee program clients into more expensive mutual fund shares that benefited the adviser and disadvantaged the client. Two more cherry picking cases were filed this week, bottomed on a statistical analysis of the trading. In addition, another action was brought against an adviser that failed to follow its procedures when charging and allocating fees to managed funds and their portfolio companies. And, a settled insider trading action was filed against a PWC auditor and his tippee relative.

SEC Enforcement – Filed and Settled Actions

Statistics: Last week the SEC filed 1 civil injunctive case and 4 administrative proceedings, excluding 12j and tag-along proceedings.

Fees: In the Matter of Suntrust Investment Services, Inc., Adm. Proc. File No. 3-18178 (Sept. 14, 2017). Respondent is a wholly owned subsidiary of SunTrust Banks, Inc. It is a registered broker-dealer and investment adviser. From late 2011 through mid 2015 the firm and its representatives disadvantaged wrap fee program clients by frequently recommending Class A mutual fund shares when institutional shares were available. The former carry 12b-1 fees which are paid out of fund assets and go to the adviser and the registered representative. The fees reduce the return to the share purchasing client. While the adviser’s Form ADV noted that it may receive such fees, there was no disclosure about the variety of shares available. The firm also did not have policies and procedures in place that would have required that the less expensive shares be purchased. Although the staff presented this issue to the firm following its mid-2015 compliance review, the adviser did not begin making refunds regarding the 4,500 accounts impacted until the staff investigation began. The Order alleges violations of Advisers Act Sections 206(2), 206(4) and 207. To resolve the matter the firm consented to the entry of a cease and desist order based on the Sections cited in the Order and to a censure. The firm will also pay disgorgement of $34,560.93, prejudgment interest and a penalty of $1,148,071.77. The disgorgement represents the remainder of the payments due to impacted accounts. The Commission considered the remedial acts of the firm in accepting the offer of settlement.

Insider trading: SEC v. Gupta, Civil Action No. 23934 (Sept. 13, 2017) is an action against PWC auditor Mayank Gupta and Pushpendra Agrawal, his cousin-in-law. Through his audit work Mr. Gupta learned that Cavium was preparing to acquire QLogic Corp. Prior to the deal announcement Mr. Gupta called Mr. Agrawal and told him about the deal. Mr. Agrawal purchased 200 QLogic call options when he arrived at work that morning. During his lunch break he purchased an additional 50 options. Following the deal announcement the price increased 9%, giving Mr. Agrawal profits of $23,785. The complaint alleges violation of Exchange Act Sections 10(b) and 14(e). To resolve the case each defendant consented to the entry of a permanent injunction based on the Sections cited in the complaint. In addition, Mr. Gupta agreed to pay a penalty of $23,785 while Mr. Agrawal will pay disgorgement in the same amount, prejudgment interest and a penalty of $11,892. The amount of Mr. Agrawal’s penalty reflects his cooperation. See Lit. Rel. No. 23934 (Sept. 13, 2017).

Cherry picking: In the Matter of Howarth Financial Services, LLC, Adm. Proc. File No. 3-18172 (Sept. 12, 2017) is an action against Howarth Financial, a state registered adviser, and its founder, principal and sole owner, Gary Howarth. The action centers on the period from late March 2012 through early July 2013. During the period Respondents used two approaches to cherry pick trades. In the first Mr. Howarth allocated favorable purchases to his personal accounts while losing trades went to those of the clients. The second method involved the use of an omnibus account to first sell and then purchase shares of the same security. The process began generally with the sale of a security held in firm client accounts but not in Mr. Howarth’s personal accounts. If the price declined Respondent purchased the same number of shares at the lower price and then allocated the trade to his personal account. That allocated the profit to the personal account. If the price did not decline no purchase was made. Rather, Mr. Howarth typically allocated the sale to the client accounts. The Order alleges violations of Exchange Act Section 10(b) and Advisers Act Sections 206(1) and 206(2). To resolve the matter each Respondent consented to the entry of a cease and desist order based on the Sections cited in the Order. Mr. Hawarth was also barred from the securities business. Respondents were ordered, on a joint and several basis, to pay disgorgement of $38,172, prejudgment interest and a penalty of $160,000.

Cherry picking: In the Matter of Jeremy A. Licht, Adm. Proc. File No. 3-18171 (Sept. 12, 2017). Mr. Licht is the founder, principal, COO and owner of JL Capital Management, a sole proprietorship and a registered investment adviser. From January 2011 through September 2012 one broker was used for trading; between October 2012 and March 2016 a second broker was used to custody accounts. Trades were made and allocated using an online platform from the brokerage. By trading in an omnibus account and delaying allocation to a specific account until the intra-day performance could be observed, Mr. Lichht executed a fraudulent cherry picking scheme. For example, while the accounts were at the first broker Mr. Licht’s total first day profits – realized and unrealized – were at least $35,933, representing a 1.01% return. In contrast the clients suffered aggregate unrealized first day loses of $77,700, representing a -2.15% return. Similar results occurred while the accounts were at the second broker. The difference between Mr. Lieht’s first-day returns and that of his clients is statistically significant. The probability that the disproportionate allocation of favorable trades to Mr. Licht and the first broker was due to random change was less than one in a trillion; for broker two it was less than one in a million. Since 2012 Mr. Licht has reaped at least $88,504. Mr. Licht admitted to the scheme in testimony. The Order also alleges that false statements were made in Forms ADV. Those Forms represented that accounts would not be favored in the allocation process. The Order alleges violations of Exchange Act Section 10(b) and Advisers Act Sections 206(1) and 206(2). To resolve the matter Respondent consented to the entry of a cease and desist order based on the Sections cited in the Order. He was also barred from the securities business. In addition, he agreed to pay disgorgement of $88,504, prejudgment interest and a penalty of $181,000.

Procedures: In the Matter of Potomac Asset Management Company, Adm. Proc. File No. 3-18168 (Sept. 11, 2017). Potomac Asset is a registered investment adviser. Its founder, control person, and president, Goodloe Byron, Jr. is also named as a Respondent. He controls the general partner of Fund I and Fund II. Potomac Asset provides advisory and management services to Fund I and Fund II. The LPA for each Fund dictates that certain capital contributions be made in a timely manner. Those LPAs also set the amount of management fees paid by the Funds and Potomac Assets’ obligation to pay the operating expenses. The LPAs do permit Potomac to provide services to portfolio companies held by either of the Funds in return for remuneration. The Fund involved is entitled to receive a 50% reduction in management fees. Between 2012 and 2013 Potomac Asset provided services that resulted in $2.2 million in charges to a portfolio company of Fund I. Potomac Asset, however, charged the fees to Fund I rather than the portfolio company and failed to discount the fees. During the period the adviser also improperly charged certain expenses to the Funds which were also not disclosed in the audited financial statements as related party transactions. That meant that the financial statements were not prepared in accord with GAAP and could not be used to secure an exception to the custody rule. Finally, Mr. Bryon failed to make his capital contributions in accord with the dictates of the LPAs. And, the firm failed to properly implement its compliance policies and procedures. The Order alleges willful violations of Advisers Act Section 206(2), 206(4) and 207. To resolve the matter, Potomac Asset undertook certain remedial actions. Each Respondents consented to the entry of a cease and desist order based on the Sections cited in the Order. The firm also consented to the entry of a censure. Respondents will, jointly and severally, pay a penalty of $300,000.


Omissions/AML: Following a hearing C.L. King & Associates was fined $750,000 for negligent misrepresentations and omissions in connection with certain investments and AML violations. Its AML Compliance Officer, Gregg Miller, was suspended for six months and fined $20.000. First a hearing panel concluded that the firm failed to disclose to issuers of purchased bonds that the instruments were acquired by a hedge fund customer that purchased the bonds at a discount as joint tenants who were paid $10,000 each to participate and were terminally ill. On the death of the terminally person the fund had a right to redeem the bond at full value. Second, from 2009 through 2014 the firm allowed a foreign bank to liquidate 40 penny stock for over $4.8 million and another customer to sell more than 11 billion shares in 138 stocks for proceeds of over $14 million. Respondents ignored red flags that included the fact that the issuers whose stock was sold generated little or no revenue and they had little or no business activity.

Criminal cases

Offering fraud: U.S. v. Peralta, No. 1-16-cr-00354 (S.D.N.Y.) is a previously filed action in which defendant Hamlet Peralta pleaded guilty to operating a Ponzi scheme. Over a period of about one year beginning in 2013 Mr. Peralta raised about $12 million from investors who were told that their money would be invested in a wholesale liquor business he called 125th Street Liquors. In fact there was no such business. Rather, Mr. Peralta solicited the funds when he was overwhelmed by debts. From one investor he obtained about $2 million. The Court sentenced him to serve five years in prison followed by three years of supervised release. He was also ordered to forfeit over $5 million and to pay restitution in the same amount.


Misleading clients: The Australian Securities and Investment Commission banned financial adviser Daniel Manley of Wilsons for five year. The Commission found that he created misleading documents at Wilsons and furnished incorrect and misleading information to clients regarding their option trading accounts.

Best interests of client: The ASIC banned financial adviser Lawrence Toledo, formerly of Sentinel Private Wealth Pty Ltd., from the securities business. The regulator concluded that in advising certain clients Mr. Toledo failed to properly identify their objectives and financial needs, to understand what was in their best interests when giving financial advice and to furnish proper advice that was appropriate.

Hong Kong

MOU: The Securities and Futures Commission entered into an agreement with the Securities Commission Malaysia to establish a framework of cooperation on financial technology or Fintech. The agreement follows the SFC’s Fintech Contact Point in 2016 which was established to facilitate the Fintech community’s understanding of the current regulatory regime and enable the Commission to say abreast of development in the area.

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