This Week In Securities Litigation (Week ending September 29, 2017)
Cybersecurity was front and center this week, with SEC Chairman Jay Clayton being grilled by a Senate Committee about the breach at the agency. The Chairman testified that the breach occurred last year and that investigations are underway. Mr. Clayton also noted that a new cyber unit has been formed as part of the Enforcement Division. Its mission is to focus on the increasing number of cases tied to the issue.
This week the Commission brought actions based on: insider trading, investment adviser advertising and conflicts, the valuation of complex instruments and the payment of bribes in connection with a domestic merger.
Testimony: Chairman Jay Clayton testified before the Committee on Banking, Housing and Urban Affairs, U.S. Senate (Sept. 26, 2017). His testimony reviewed the cybersecurity issues at the Commission, facilitating capital formation, disclosure issues, the fiduciary rule, enforcement and resources (here).
Enforcement unit: The Commission announced the formation of a cyber unit to focus on issues related to market manipulation schemes involving false information spread through electronic and social media, hacking to obtain inside information, intrusions and other similar issues (here).
SEC Enforcement – Filed and Settled Actions
Statistics: Last week the SEC filed 5 civil injunctive cases and 7 administrative proceedings, excluding 12j and tag-along proceedings.
Suitability: SEC v. Gennity, Civil Action No. 1:17-cv-07424 (S.D.N.Y. Filed Sept. 28, 2017) is an action against two brokers formerly at Alexander Capital, L.P, William Gennity and Rocco Roveccio. From 2012 through 2014 both men repeatedly made recommendations to clients that were unsuitable. Specifically, Mr. Gennity recommended to four customers and Mr. Roveccio to seven, a rapid trade in and out strategy that had no reasonable basis. It did, however, generate significant commissions for them, respectively, $280,000 and 206,038. The complaint alleges violations of Securities Act Section 17(a) and Exchange Act Section 10(b). The case is pending. See also In the Matter of Laurence M. Torres, Adm. Proc. File No. 3-18233 (Sept. 28, 2017)(proceeding against another Alexander Capital registered representative based on suitability as noted above; settled with a cease and desist order based on the same Sections cited above, and the entry of an order barring Respondent from the securities business and from participating in any penny stock offering; and the payment of $225,359.36 in disgorgement, prejudgment interest and a penalty of $160,000.
Fraudulent trading scheme: SEC v. Chamroonrat, Civil Action No. 16-cv-09403 (D.N.J.) is a previously filed action against Naris Chamroonrat and others. The action alleged that defendants lured investors into what was claimed to be an opportunity to day trade on generous terms through Nonko Trading and then misappropriated their funds. Mr. Chamroonrat agreed to settle and the court entered a permanent injunction prohibiting future violations of Securities Act Sections 17(a) and Exchange Act Sections 10(b), 15(a)(1) and 20(b). He also agreed to pay disgorgement of $918,147.31 and prejudgment interest, payment of which will be deemed satisfied by the restitution ordered in the parallel criminal case in which Mr. Chamroonrat pleaded guilty and is awaiting sentencing. See Lit. Rel. No. 23946 (Sept. 28, 2017).
Unregistered securities: In the Matter of Success Holdings Group International, Inc., Adm. Proc. File No. 3-18230 (Sept. 28, 2017) is an action against the firm which claims to conduct seminars largely in China and invest in internet short films. In 2014 the firm is alleged to have violated the registration provisions by selling shares of its unregistered stock to a person retained to provide IR services, knowing the shares would immediately be resold. The firm has also failed to file its periodic reports since mid-2015. The Order alleges violations of Securities Act Sections 5(a) and 5(c) and Exchange Act Section 13(a). To resolve the action the firm agreed to certain undertakings, consented to the entry of a cease and desist order based on the Sections cited in the Order and will pay disgorgement of $36,000 along with prejudgment interest and a civil penalty of $100,000.
Insider trading: In the Matter of Fengjiu Zhang, Adm. Proc. File No. 3-18227 (Sept. 28, 2017) is an action which names as Respondents Mr. Zhang, an executive at the Canadian subsidiary of Chinese oil company CNOOC Ltd. and his long time friend Xianli Kong. Shortly before the closing date of the merger between CNOOC and Canadian oil firm Nexen Inc. Mr. Zhang had a friend — Trader A who also traded profitably — in the U.S. purchase 9,000 shares of Nexen for him. He also tipped Mr. Kong who purchased shares. Mr. Zhang had trading profits of $65,769.20 while his friend had profits of $11,493.23. The Order alleges violations of Exchange Act Section 10(b). To resolve the proceedings each Respondent consented to the entry of a cease and desist order based on the Section cited in the Order. Mr. Zhang agreed to pay disgorgement of $77,260.43 and prejudgment interest. His payment obligations will be offset by the receipt of the trading profits Trader A holds in escrow and the payment Mr. Kong of disgorgement of his trading profits. Mr. Zhang is also barred from serving as an officer or director of a public company.
Unregistered investment company: In the Matter of Honeysuckle Research Inc., Civil Action No. 3-18232 (Sept. 28, 2017) is an against the firm whose predecessor registered its securities on a Form S-1 that became effective in December 2013. The shares are quoted on OTC Link. Since then the firm has only been engaged in the business of trading securities. It currently owns over $9 million in securities. The firm has never registered as an investment company. The Order alleges violations of Investment Company Act Section 7(a). To resolve the proceedings the firm agreed to certain undertakings and consented to the entry of a cease and desist order based on the Section cited in the Order with a 60 day widow to come into compliance. The firm will also pay a penalty of $20,000.
Valuation: In the Matter of Six Financial Information USA Inc., Adm. Proc. File No. 3-18234 (Sept. 28, 2017) is an action against the firm which provides financial information for portfolio management and financial analysis. Here the firm agreed to value four complex European options held by several series of a managed futures fund. Rather than actually do the valuations, Respondent made certain adjustments to a calculation made by the firm which held the instruments. Respondent thus mislead the investment firm regarding the type of work done. The Order alleges violations of Advisers Act Section 206(2). To resolve the matter Respondent consented to the entry of a cease and desist order based on the Section cited in the Order. In addition, the firm will pay disgorgement of $27,411, prejudgment interest and a penalty of $27,000. See also In the Matter of Perry H. Beaumont, Adm. Proc. File No. 3-18235 (Sept. 28, 2017)(proceeding against the prior owner of the valuation firm alleging violations of Advisers Act Section 206(2); resolved with the entry of a cease and desist order based on the Section cited in the Order, the entry of a bar from the securities business with the right to apply for re-entry after one year and the payment of a $50,000 penalty).
Bribes: SEC v. Pulier, Civil Action No. 2:17-cv-07124 (C.D. Cal. Filed Sept. 27, 2017) is an action which names as defendants: Eric Pulier, the founder, president and major shareholder of Defendant ServiceMesh, Inc, a cloud software startup and an EVP of Defendant Computer Sciences Corporation; Keith Hunter, an EVP of IT Engineering at Commonwealth Bank of Australia; and Commonwealth Bank of Australia. Mr. Pulier is alleged to have defrauded Computer Sciences out of over $98 million in connection with its November 2013 acquisition of ServiceMesh. Specifically, in order to obtain an earn-out payment as part of the deal which was dependent on ServiceMesh hitting certain sales targets, Mr. Pulier bribed two executives at Commonwealth Bank to enter into contracts with Computer Sciences in December 2013 and January 2014 which increased the revenues of the two firms by over $10 million. As a major shareholder Mr. Pulier received over $30 million of the earn-out payment. Mr. Pulier also used his position at Computer Sciences to falsely attest that there were no side deals and that there was no fraud in connection with the audit of ServiceMesh. In March 2015 the New South Sales Police arrested the two bank executives for the bribes. The complaint alleges violations of Securities Act Section 17(a) and Exchange Act Sections 10(b) and 13(b)(5). The case is pending. See Lit. Rel. No. 23945 (Sept. 27, 2017).
Unregistered broker: SEC v. Welch, Civil Action No. 17-cv-01968 (C.D. Cal. Filed Sept. 27, 2017) is an action against four individuals – David Welch, Marc Bryant, John Knight and Perry West – and five entities: Bio-Global Resources, Inc. Diversified Equities Inc. Diversified Equities Development, Inc. and New Global Energy Inc. The action centers on raising over $10 million from about 500 investors who were cold-called and purchased unregistered securities over a four year period beginning in 2011. Specifically, Defendants Welch, Bryant and Knight, through a number of shell companies that included Defendants Bio-Global, Diversified Equities and Diversified Equities Development, acted as unregistered brokers, effecting transactions in the securities of Global Energy, New Global and other companies. Defendants Welch and Bryant used Bio-Global to acquire millions of shares of Global Energy and New Global which were used to solicit investors through shell companies. Defendant Vertex, and later Bechtel, were used to solicit and sell shares of Bio-Global Energy. The complaint alleges violations of Securities Act Sections 5(a) and 5(c) and Exchange Act Sections 15(a) and 20(a). Defendants Knight and Diversified Equities resolved the action, consenting to the entry of permanent injunctions based on the Sections cited in the complaint (except 15(a) and 20(b) as to Diversified Equities) and to a penny stock bar as to Mr. Knight. Mr. Knight also agreed to be barred from the financial industry. Financial penalties will be assessed at a later date. See Lit. Rel. No. 23947 (Sept. 28, 2017).
Insider trading: SEC v. Napodano, Civil Action No. 1:17-cv-06917 (N.D. Ill. Filed Sept. 26, 2017). Named as defendants are Jason Napodano, the former head research analyst of Zacks Small Cap Research; Bilal Basrai, former head of the investment banking division of LBMZ Securities, Inc., a registered broker dealer; and Bryce Stirton, an employee of LBMZ’s investment banking division. Defendants traded on inside information they obtained, with one exception, through their employment. In each instance they shared the information and traded profitably. In the one instance where the information was not from their employment Mr. Basrai obtained it from a friend at another firm on the promise it would remain confidential. It did not. All three men traded profitably. Defendants also traded in advance of the publication of Zacks research reports. Specifically, between August 2012 and June 2015 Mr. Napodano traded in advance of 42 research reports. Similarly, in early July 2014 an analyst who reported to Mr. Napodano told his two co-defendants that the first report on a clinical lab company was being issued. All three men purchased shares the day before the report was issued. The shares were sold at a profit after the report was issued the next day. Finally, between August 2012 and June 2015 Mr. Napodano traded profitably in advance of the publication of 100 reports issued by Zachs. In each instance the report had a disclaimer about either the author or firm employees not trading which was rendered false by the trades. Collectively the defendants generated trading profits of about $185,000. The complaint alleges violations of Exchange Act Section 10(b). To resolve the case Mr. Napodano agreed to pay disgorgement of $143,865.48, prejudgment interest and a penalty equal to the amount of the disgorgement. He also agreed to the entry of a penny stock bar. Mr. Basrai agreed to pay disgorgement of $39,668.37, prejudgment interest and a penalty equal to the amount of the disgorgement. Mr. Stirton agreed to pay disgorgement of $2,218.87, prejudgment interest and a penalty equal to the amount of his trading profits. Both investment bankers agreed, in addition, to the entry of penny stock bars and to be barred from the securities business. Mr. Stirton has the right to reapply after five years. Both investment bankers were named as defendants in a parallel criminal action brought by the U.S. Attorney’s Office for the Northern District of Illinois. In a separate action LBMZ agreed to be censured and pay a $240,000 penalty based on a failure to supervise charge. See Lit. Rel. No. 23943 (Sept. 26, 2017).
Conflicts: In the Matter of Marshall G. Eichenauer, Jr., Adm. Proc. File No. 3-18200 (Apr 22, 2017). Marshall Eichenauer is the founder, president and sole owner of Sagent Wealth Management, LLC, also a Respondent. The firm is a registered investment adviser. Mr. Eichenauer also formed two investment funds in 2010. One was Sagent Private Investment Fund I, LLC. The other was Sagent Fund Management LLC. Sagent Private Investment paid Mr. Eichenauer or Sagent advisory management fees. Under Sagent’s operating agreement Mr. Eichenauer was entitled to receive an annual distribution of $450,000 in quarterly installments. Beginning in July 2012 Sagent also paid Mr. Eichenauer an annual salary of $100,000. In 2011 and 2012 Sagent did not generate sufficient revenue to pay Mr. Eichenauer’s distribution payments. Beginning in March 2012 Mr. Eichenauer sold large portions of Sagent Private Investment’s publicly traded securities held in the Balance Fund which was essentially a liquid reserve to cover withdrawals. The proceeds were loaned to Sagent so that firm could pay at least a portion of Mr. Eichenauer’s distribution payments evidenced by a series promissory notes. The notes were executed between September 2012 and January 2015, totaling of $326,650. The Balance Fund was reduced to less than $1,000 by January 2015. Prior to making the loans to Sagent, Mr. Eichenauer consulted counsel who advised investor consent was not required. Counsel was not consulted about whether the loans should be disclosed. They were not. Indeed, investors were not informed about the loans until after the first loan was made in March 2012. While after that date some disclosure was made, the conflict of interest “that the primary purpose of each loan was to pay Eichenaauer’s distributions,” was not included in the disclosure according to the Order. The Order alleges violations of Advisers Act Sections 206(2), 206(3) and 206(4). In resolving the matter, Respondents agreed to implement a series of undertakings including the distribution of certain funds to investors, the retention of a consultant and the circulation to clients of a copy of the Order. Respondents also consented to the entry of a cease and desist order based on the Sections cited in the Order and to a censure. They will pay, jointly and severally, disgorgement of $15,380, prejudgment interest and a penalty of $165,000.
Misrepresentations: SEC v. Aegerion Pharmaceuticals, Inc., Civil Action No. 1:17-cv-11817 (D. Mass. Filed Sept. 22, 2017) is an action which names the pharmaceutical firm as a defendant. In 2013 – 2014 the firm had one drug known as Juxtapid which was used to treat a rare and potentially life-threatening genetic condition. At the time the drug was priced at about $250,000 to $300,000 per patient per year. The firm mislead investors regarding the “conversion rate” — the percentage of prescriptions written for the drug which were actually filled. During public conference calls discussing the firm’s then CEO noted that the conversion rate was not a material number and that the vast majority of prescriptions for the drug were filled. In fact the conversion was about 50%. This improperly inflated the firm’s stock price. The complaint alleges violations of Securities Act Sections 17(a)(2) and (3). The case is pending. See Lit. Rel. No. 23942 (Sept. 22, 2017); See also U.S. v. Aegerion Pharmaceuticals, Inc., No. 1:17-cr-10289 (D.Mass.)(company agreed to plead guilty to misbranding drug; entered into deferred prosecution agreement re conspiracy charge; and settled false claim action).
Advertising: SEC v. Moses, Civil Action No. 1:17-cv-02296 (D. Colo. Filed Sept. 22, 2017) names as defendants Michael Moses and Moses Investment Company, a state registered investment adviser the general partner of the WAKE Fund. The complaint alleges that the defendants misrepresented Moses’ past experience as a trader or portfolio manager with large private advisers as well as past investment performance and the safety of the investments in the WAKE Fund. Defendants also made misrepresentations regarding the personal investments of Defendant Moses in the WAKE Fund. The complaint alleges violations of Securities Act Section 17(a)(2), Exchange Act Section 10(b) and Advisers Act Section 206(4). The case is pending. See Lit. Rel. No 23941 (Sept. 22, 2017).
Supervision: The regulator brought an against Morgan Stanley Smith Barney focused on unit investment trusts or UITs. A UIT is an investment company that offers units in a portfolio of securities which terminates on a specific date. Frequently the termination date is 15 to 24 months out. UITs impose a number of charges which include a deferred sales charge and a creation and development fee that can total about 3.95% for the typical 24 month period. Rolling the investment over prematurely results in increased sales charges. From January 2012 through June 2015 hundreds of Morgan Stanley representatives executed short term UIT rollovers. Many were executed more than 100 days prior to maturity. These actions involved thousands of customer accounts. During the period Morgan Stanley failed to adequately supervise representatives’ sales of UITs by providing insufficient guidance to supervisors regarding how they should review UIT rollover transactions to detect unsuitable short-term trading. During the period the firm failed to implement an adequate system to detect short-term rollovers. It also failed to provide for supervisory review of rollovers prior to execution within the firm’s order entry system or adequate training to representatives involved. In resolving the action the regulator acknowledged Morgan Stanley’s cooperation. Morgan Stanley did not admit or deny FINRA’s findings but consented to the settlement and agreed to pay $9.78 million in restitution to over 3,000 affected customers and a fine of $3.25 million.
Unauthorized transactions: The Securities and Futures Commission banned Shum Kam Ming, formerly an executive at Sincere Securities Limited, permanently from the securities business. The action was based on findings that from March 2014 through May 2015 the account executive had engaged in: unauthorized transactions in a client account; altered the delivery of statements to the client; furnished false statements to the client; and forged the client’s signature.
Anti-corruption: The Serious Frauds Office secured seven convictions or guilty pleas of current or former employees of F.H. Bertling of conspiracy to make corrupt payments to an agent of the Angolan state oil company, Sonangol. The payments related to F.H. Bertling’s freight forwarding business in Angola and a contract worth about $20 million. One defendant was acquitted.