This Week In Securities Litigation (Week of April 27, 2020)
Risk is a much talked about concept these days, typically in the context of the pandemic regarding the virus. There it is difficult to assess the risk largely because of the unknowns.
Risk was also a key issue for the Commission this week. Chairman Clayton, PCAOB Chairman Duhnke and others issued a statement advising investors about “emerging market investments” and the risk associated there. This applies to issuers in those markets, as well as firms that may have a subsidiary or affiliate in one of those jurisdictions. Perhaps the most interesting statement is one under the title and the list of authors: “The PCAOB’s Inability to Inspect Audit Work Papers in China Continues.” This is a risk that Congress addressed in 2002 in Sarbanes Oxley Act. The risk remains unknown.
SEC Enforcement brought a series of cases involving the FCPA, the end of the share class selection cooperation initiative and of course offering frauds.
Be safe; be well
Proposal: The Commission approved on April 21, 2020 a proposal to establish a new framework for fund valuation practice. The issue was last addressed in 1969 and 1970 (here). It focuses on valuation practices and the role of the board of an investment company. If adopted the proposed new rule would, in part, provide requirements for determining fair value in good faith for a fund under the Act.
Remarks: Commissioner Hester M. Peirce, Statement on Good Faith Determinations of Fair Value under the Investment Company Act of 1940 Proposal, issued April 21, 2020 (here).
Risk: The agency published a statement titled Emerging Market Investments Entail Significant Disclosure, Financial Reporting and Other Risks; Remedies are Limited. It was issued by Commission Chairman Jay Clayton, PCAOB Chairman William D. Duhnke III and others on April 21, 2020 (here). The statement discusses various investor risks regarding firms located in, or that have subsidiaries in emerging markets. Those markets may be less transparent, have fewer procedures and a lack of safeguards compared to the U.S. markets.
Exemption: The agency approved, on April 20, 2020 ,an order that will provide for two exemptions regarding the Consolidated Audit Trail in view of COVID-19. The first is for establishing a phased CAT reporting timeline for broker-dealers. The second will permit introducing brokers that meet certain requirements to follow the small broker-dealer reporting timeline (here).
Whistleblower: The Commission announced, on April 20, 2020, that $5 million had been awarded to a whistleblower for providing critical evidence of wrongdoing that saved time and resources in an investigation.
SEC Enforcement – Filed and Settled Actions
The Commission filed 4 civil injunctive action and 9 administrative proceedings last week, exclusive of 12j and tag-along actions, discussed below.
Offering fraud: SEC v. Hudnall, Civil Action No. 20-cv-327 (W.D. Mo. Filed April 23, 2020) names as defendants: Phillip Hudnall, who controlled the entity defendants; Todd Esh, a former registered representative; Birddog Business Group, LLC; and Birddog Oil Equipment, LLC. Since June 2019 Defendants have raised over $3.6 million selling promissory notes issued by Birddog. Investors were told that the funds would be used to purchase oil equipment. The notes were a safe investment because they were supposedly secured by the equipment, paid 30% in a short period and the individual Defendants had substantial experience in this area. In fact, the representations were false. The individual Defendants misappropriated much of the money while making Ponzi type payments to investors. The equipment was transferred to other entities. The complaint alleges violations of Securities Act Section 17(a) and Exchange Act Section 10(b). Mr. Esh settled, consenting to the entry of permanent injunctions based on the sections cited in the complaint. The question of monetary relief is reserved for later consideration by the Court on motion of the Commission. The case is pending. See Lit. Rel. No. 24803 (April 23, 2020).
Offering fraud: SEC v. Renew Spinal Care, Inc., Civil Action No. 2:20-cv-03676 (C.D. Ca. Filed April 22, 2020) is an action which names as defendants Renew Spinal, Laserscopic Medical Clinic, LLC, both controlled by Defendant Joe Bailey, and, in addition, Barry Mitchell, Laurence Grossnickle and Charles Clement Goubert, Jr. Over a period of about 18 months, beginning in February 2016, about $15 million was raised from at least 200 investors in 13 fraudulent unregistered securities offerings. Investors were solicited to purchase notes. The funds were supposed to be used to establish and market a number of minimally invasive special surgery centers across the country. In fact, much of the money was misappropriated by Defendants. The complaint alleges violations of Securities Act Sections 5(a), 5(c) and 17(a) and Exchange Act Section 10(b). Each Defendant settled, consenting to the entry of a permanent injunction based on Securities Act Section 17(a)(1) and (3) and Exchange Act Section 10(b). Mr. Mitchell agreed to pay $634,123 in disgorgement and $61,231 in prejudgment interest; Mr. Grossnickle will pay $210,031 in disgorgement and $61,231 in prejudgment interest; and Mr. Goubert $69,089 in disgorgement and $6,671 in prejudgment interest. Messrs. Bailey, Renew and Laserscopic agreed to pay, on a joint and several basis, $4,950,000 in disgorgement and $410,476 in prejudgment interest. See Lit. Rel. No. 24802 (April 22, 2020).
Conflicts: SEC v. Bekkedam, Civil Action No. 2:14-cv-02488 (E.D. Pa.) is a previously filed action against the CEO of a registered investment adviser, Richard Bekkedam. In early 2009 Mr. Bekkedam was approached by a person who solicited investors for a fund that supposedly purchased on a discounted basis settlements in sexual harassment and other, similar types of lawsuits. The two men formed an entity to invest in the suits. When soliciting investors Mr. Bekkedam failed to disclose the lack of due diligence on the investments in the lawsuit fund and additional conflicts with those operating the fund. About $100 million was raised from investors. The lawsuit fund was later discovered to be a Ponzi scheme. Mr. Bekkedam resolved the action, consenting to the entry of a permanent injunction based on Securities Act Section 17(a), Exchange Act Section 10(b) and Advisers Act Sections 206(1) and 206(2). He also agreed to pay disgorgement of $150,000 and $70,969 in prejudgment interest. See Lit. Rel. No. 24801 (April 22, 2020).
Conflicts: In the Matter of Monomoy Capital Management, L.P., Adm. Proc. File No. 3-19764 (April 22, 2020) is a proceeding which names the registered investment adviser as Respondent. Over a four year period, beginning in April 2012, the adviser touted its internal Operations Group as a value addition for the funds managed. What the adviser failed to fully disclose was the charges imposed for the claimed benefits. The Order alleged violations of Advisers Act Sections 206(2). To resolve the matter the firm consented to the entry of a cease and desist order based on the section cited and to a censure. The firm also agreed to pay disgorgement, prejudgment interest and a penalty in the amount of $1,926,579 as follows: Disgorgement of $1,521,972, prejudgment interest of $204,606; and a penalty in the amount of $200,000. The Commission considered the cooperation of the firm.
False statements: In the Matter of Brian M. Storms, Adm. Proc. File No. 3-19760 Adm. Proc. File No. 3-19760 (April 22, 2020) is a proceeding which names as a Respondent Brian M. Storms, the CEO of Liquid Holdings Group, Inc. which is now in bankruptcy. In the firm’s filings for the third quarter of 2013 through the second quarter of 2014 it claimed to have the ability to readily expand its customer base which was identified as a mark of the growth of its business. In fact, the statement was false. During the period QuantX was its largest customer and a related party although it was represented to be only a small part of the customer base. What was not disclosed is that the firm’s customers were largely referred by QuantX, a partner funded trading firm. More importantly, that client was funded almost exclusively by one trader. The Order alleged that Respondent caused the firm’s violations of Exchange Act Section 13(a). To resolve the proceedings Mr. Storms consented to the entry of a cease and desist order based on the section cited in the Order. He also agreed to pay a penalty of $40,000. See also In the Matter of Kenneth D. Shifrin CPA, Adm. Proc. File No. 3-19759 (April 22, 2020)(proceeding against the CFO of the firm; resolved on similar terms but for a $25,000 penalty); In the Matter of Brian L. Ferdinand, Adm. Proc. File No. 3-19758 (April 22, 2020)(proceeding against the founder of the firm; resolved with a cease and desist order based on Securities Act Section 17(a)(2) and Exchange Act Sections 13(a), 13(d)(2) and 16(a) and the payment of a penalty in the amount of $115,000).
Offering fraud: SEC v. Brickner, Civil Action No. 8:20-cv-00921 (M.D. Fla. Filed April 21, 2020). Defendant Steven Brickner was the principal of a pharmaceutical company and a series of related entitles. He claimed on Linkedin to have created a number of venture capital, finance and other commercial firms in the Tampa, Florida area. Mr. Brickner began soliciting investors in 2015 for a venture he formed in September 2016 in Colorado called High Country. The privately held firm was projected to become publicly traded and then a Colorado licensed marijuana dispensary network based on assets to be acquired. Potential investors were told that their funds would be used to acquire the assets necessary for High Country to enter the marijuana business. The deal was supposedly “on track” for the firm to become the largest cannabis operation in the United States by the fourth quarter of 2017. Mr. Brickner was engaged in planning an IPO for the second or third quarter of that year investors were told. The projections valued the offering at $2.6 million. Current investors would thus have a 2500 to one conversion ratio, according to the pitch. The solicitations brought in about $5.5 million from 60 investors. The claims were false. There was no deal; no planned IPO; no trademarked logo. Mr. Brickner’s hand was on the cash however – he misappropriated large portions of the investor money. The Commission’s complaint alleges violations of Securities Act Section 17(a) and Exchange Act Section 10(b). The case is pending. See Lit. Rel. No. 24800 (April 21, 2020).
Offering fraud: In the Matter of Old Ironsides Energy, LLC, Adm. Proc. File No. 3-19750 (April 17, 2020) is a proceeding which names the registered investment adviser as a Respondent. Beginning in 2014, and continuing for another year and one half, the firm distributed marketing materials for a private fund. Those materials described an investment in a private fund advised by a third party as an interest in a legacy oil and natural gas investment. The representation was not correct. The distribution of the false materials also violated the firm’s policies and procedures which prohibited such actions. The Order alleges violations of Advisers Act Section 206(4). To resolve the matter Respondent consented to the entry of a cease and desist order based on the section cited in the Order and to a censure. Respondent also agreed to pay a penalty of $1 million.
Conflicts: In the Matter of Cozad Asset Management, Inc., Adm. Proc. File No. 3-19752 (April 17, 2020). The firm is a registered investment adviser. Over a four year period, beginning in 2014, the adviser offered and sold mutual fund shares to its clients that carried 12b-1 fees. Those fees are typically charged to cover select expenses. Certain of the associated persons of an unaffiliated broker-dealer received the 12b-1 fees that they would not have obtained if the clients had invested in the available lower-cost share class. While the adviser made certain disclosures to its clients, they were not adequate. The firm brochure stated that clients would normally incur transactions costs that included sales charges, commissions, and/or markups. The brochure also stated that its associated persons “may” receive 12b-1 fees from the sale of mutual funds and that the availability of such fees created a conflict. The disclosures in the brochure were not adequate. Investment advisers have a duty to disclose all material facts to advisory clients, including any conflict of interest. To meet this fiduciary obligation “Respondent was required to provide its advisory clients with full and fair disclosure that is sufficiently specific so that they could understand the conflicts of interest concerning Respondent’s and its associated persons’ advice about investing in different classes of mutual funds and could have an informed basis on which they could consent or reject the conflicts,” according to the Order. In this matter, Respondent failed to fully comply with this obligation. The firm also failed to adopt and implement written policies and procedures reasonably designed to prevent violations of the Advisers Act. Respondent self-reported shortly after the close of the Commission’s share class cooperation initiative. The firm is considered to be one of the last associated with it nevertheless. The firm undertook remedial acts which the Commission considering in resolving this matter. To resolve the matter Respondent consented to the entry of a cease and desist order based Advisers Act Sections 206(2) and 206(4) and to a censure. The firm also agreed to pay disgorgement of $369,423.75, prejudgment interest of $37,446.35 and a $10,000 penalty. Those sums will be placed in a fair fund and returned to the investors involved. See also In the Matter of Eagle Strategies LLC, Adm. Proc. File No. 3-19755 (April 17, 2020)(similar but charge limited to Section 206(2) and no penalty; self-reported prior to deadline of the initiative).
Insider trading: SEC v. Waldman, Civil Action No. 17-cv-02088 (S.D.N.Y.) is a previously filed action centered on the takeover of Israel based Mobileye, N.V. by Intel Corporation. Prior to the deal announcement James Shaoul, a close friend of Israel based Defendant Waldman told him about the deal. He purchased shares prior to the announcement. After the announcement Mr. Waldman netted over $4.5 million. To resolve the matter, he consented to the entry of a final judgment that enjoins him from future violations of Exchange Act Section 14(e). He also agreed to pay disgorgement of $1,078,300, prejudgment interest of $40,889 and a penalty equal to the amount of the disgorgement. The Court entered the judgment. Other Defendants in the case settled earlier. See Lit. Rel. No. 24799 (April 17, 2020).
Offering fraud: SEC v. Conley, Civil Action No. 1:20-CV-70 (N.D. W.Va. Filed April 16, 2020). Phillip Conley held Series 7 and 66 securities licenses while associated with a registered broker-dealer. In December 2015 Mr. Conley was suspended by FINRA from association with a broker-dealer in any capacity for failing to comply with a FINRA arbitration award. The year before Mr. Conley formed ALPAX LLC and its affiliated shell entities. ALPAX supposedly provided management and consulting services. Investors, solicited on the phone and in person, were sought for a variety of investments tied to ALPAX, some of which were discussed in PPMs used in the solicitations. For example, one PPM claimed that the funds would be invested in Student Housing tied to real estate transactions in developed higher education markets, primarily on the east coast. Another stated that the money would be invested in privately held firms in real estate identified with oil and gas technologies. In personal solicitations still other claims were made. The representations were false. There were no investments in Student Housing; no investor funds were put into oil and gas assets. In short, none of the representations about the use of funds were accurate. To the contrary the money went to Mr. Conley – he misappropriated the investor funds. 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). The case is pending. See Lit. Rel. No. 24798 (April 18, 2020).
In the Matter of Eni S.p.A., Adm. Proc. File No. 3-19751 (April 17, 2020) is a proceeding which names the Italian oil and gas firm as a Respondent. Over a three year period beginning in 2007 Saipem S.p.A., a 43% owned subsidiary entered into a series of sham transactions through which about €198 million was paid to an intermediary in order to secure the award of seven contracts from the Algerian state-owned oil firm. Executive A, the CFO of the firm at the time, participated in the approval of the intermediary contracts despite knowledge of a lack of due diligence regarding the agreements. The financial statements of the subsidiary were consolidated with those of the parent whose ADRs are listed on the New York Stock Exchange.
An Italian Court found Saipem, Executive A and others guilty of international corruption payments from the subsidiary to the intermediary for Algerian officials in September 2018. The amount ordered forfeit was €198 million. Executive A was also sentenced to serve 49 months in prison while the subsidiary was directed to pay a fine of €400,000. Eni, its former CEO and a senior executive of the parent were acquitted. In January 2020 the Milan Court of Appeals affirmed the trial court’s acquittal of Eni and its officers and overruled the lower court and acquitted the other defendants, including Saipen and Executive A, of all charges. Those rulings are subject to appeal. Previously, Eni resolved FCPA charges with the Commission.
The Order here alleged violations by Eni of Exchange Act Sections 13(b)(2)(A) and 13(b)(2)(B). To resolve the proceedings Eni consented to the entry of a cease and desist order based on the sections cited in the Order. The firm also agreed to pay disgorgement of $19,750,000 and prejudgment interest of $4,750,000.
Offering fraud: U.S v. Lahr (E.D. Pa. Guilty plea April 23, 2020) is an action in which attorney Todd H. Lahr pleaded guilty to one count of conspiracy to commit securities fraud and wire fraud, two counts of securities fraud and four counts of wire fraud. Mr. Lahr admitted that over a five year period, beginning in 2012, he and others targeted his law clients and others for the sale of fraudulent securities. The securities were in THL Holdings LLC and Global Holdings Inc. Mr. Lahr also admitted to misappropriating the investor funds. Sentencing is scheduled for August 3, 2020.
Report: The Australian Securities and Investment Commission issued a report on corporate finance regulation over the second half of 2019 on April 20, 2020. The report provides statistical data and relevant guidance on regulation by the agency regarding fundraising transactions, financial reporting, mergers and acquisitions, and other topics for the period. In the future the agency will issue quarterly newsletters (https://asic.gov.au/about-asic/news-centre/find-a-media-release/2020-releases/20-095mr-asic-notes-financial-reporting-changes/.
Release: The ASIC published a release on April 20, 2020 discussing the evolving circumstances of corporate directors in view of COVID-19 (https://asic.gov.au/about-asic/news-centre/.
Trading: The Securities and Futures Commission cautioned commodity futures brokers to take precautionary measures when trading contracts and ETFs in view of the extreme volatility in the markets.
Internal controls: The SFC reprimanded and fined BOCOM International Securities Ltd. $19.6 million tied to a range of regulatory breaches. Those included failures regarding the handling of third-party deposits and to maintain adequate and effective controls to identify deposits made into client accounts by third parties. The action is based on SFC findings.
Release – oil: The Monetary Authority of Singapore announced on April 21, 2020, in conjunction with Enterprise Singapore and the Maritime and Port Authority of Singapore, that the oil trading sector remains “resilient notwithstanding the challenges posed by the drop in global demand for energy” (here).