This Week In Securities Litigation (Week of December 14, 2020)

The exit continues at the Commission. This week Director of Enforcement Stephanie Avakian announced her departure from the agency at the end of the year. She has been preceded by the Director of Corporation Finance and the General Counsel. The Chairman previously announced his departure at year end.

Last week Enforcement filed a series of cases. Two were based on false statements tied to financial issues, one against GE and another involving CheeseCake Factory. The agency also brought two offering fraud actions, a case involving digital assets and another tied to share class selection conflicts.

Be safe and healthy this week


Statistics: The Division of Investment Management filed an expanded suite of data related to private fund statistics and trends on December 10, 2020 (here). The supplement is to the quarterly release of statistics on the funds that has regularly been published since October 2015.

Rules: The Commission approved on December 9, 2020 modifications to the rules regarding the collection of market infrastructure data. That information will now include expanded content of NMS market data, and rules establishing a decentralized consolidation model in which competing consolidators will be responsible for collecting, consolidating and disseminating consolidated market data to the public (here).

SEC Enforcement – Filed and Settled Actions

The Commission filed 3 civil injunctive actions and 6 administrative proceedings last week, excluding 12j, tag-along proceedings and other similar matters.

False statements/financial fraud: In the Matter of General Electric Company, Adm. Proc. File No. 3-2-165 (December 9, 2010). The action is built on two key omissions: First, GE failed to tell investors how its Power division made its numbers. Second, investors were not told about deteriorating trends in the insurance area and potential losses that eventually resulted in pre-tax charges. Initially, GE Power, a significant line of business that manufactures gas turbines, faced challenges in the marketplace. Business in Power was flat, according to internal documents. A large portion of the segment’s earnings and cash came from very profitable agreements that ran for years. A plan was developed to ensure that the division’s financial goals were met. The division had a $5 billion “deferred balance” of unbilled revenue reported in GE’s financial statements. Key, however, was to reduce expenses. If costs and estimated costs for the division were reduced, greater revenue would result and Power would hit its financial goals. In 2016 GE did not tell investors that 25% of Power’s reported profits were generated by reducing estimates of costs to complete the work under the long-term contracts. The next year the same technique was used in the first three quarters to significantly boost profits. Investors were told only that Power generated $1.4 billion in 2016 and $1.1 billion for the first three quarters of 2017. Investors were not told that the revenue increases were generated in part by changing estimates that compromised the cash flow for future years. The company used a similar approach to report increased industrial cash collections for 2016 and 2017. GE decided to sell or factor long term receivables from the Power service multi-year agreements primarily to GE Capital, a subsidiary of the company. This practice – called “deferred monetization” — boosted reported cash flow by over $1.4 billion in 2016 and over $500 million for the first three quarters of 2017. Second, there were issues in the insurance area. Beginning in 2004 the firm explored exiting the line of business. Portions of its insurance portfolio were divested. The long-term care insurance policies remained – a sale would generate huge losses. By 2015 and 2016 costs exceeded revenues. Despite the known trends, GE lowered projected claims costs for the distant future while concluding that it did not have insurance losses. The company did not disclose its rising claim costs and the resulting potential for material insurance losses. In 2017 and 2018 GE made a series of public announcements. They described the actual and disappointing cash and earnings in GE Power absent the changes and a $9.5 billion pre-tax insurance charge. The share price dropped about 75%. The Order alleges violations of Securities Act Section 17(a)(2) & (3) and Exchange Act Sections 13(a), 13(b)(2)(A) and 13(b)(2)(B). In resolving the matter, the Commission acknowledged the remedial actions taken by the firm which included replacing key personnel. The company consented to the entry of a cease-and-desist order based on the Sections cited in the Order and agreed to pay a penalty of $200 million. A fair fund will be created.

Digital assets/unregistered offering: SEC v. Elmaani, Civil Action No. 1:20-cv-10376 (S.D.N.Y. Filed December 9, 2020) is an action which names as a defendant Amir Bruno Elmaani aka Bruno Block. Defendant is the founder of Oyster Protocol, Inc., a firm which issues coins called Pearls. Beginning in the fall of 2017 Defendant, using the name Bruno Block, began offering and selling millions of digital tokens called Pearl, a form of unregistered security. About $1.3 million was raised. The tokens were a “hot” item for a period. In late October 2018 Defendant minted another 4 million Pearl tokens and sold them in the secondary market. He obtained about $570,000. The sales also caused losses for earlier investors when the price dropped by about 65%. The complaint alleges violations of Securities Act Sections 5(a), 5(c) and 17(a) and Exchange Act Section 10(b). The case is pending. See Lit. Rel. No. 24980 (Dec. 9, 2020).

Offering fraud: SEC v. Barbera, Civil Action No. 20-cv-10353 (S.D.N.Y. Filed Dec. 9, 2020) is an action which names as defendants J. Jeremy Barbera, Car Smith and Nanobeak Biotech Inc., respectively, the former CEO of Nanobeak who has been enjoined in a Commission fraud action, a firm that changed its name to the current version in 2019, and a resident of Florida. Over a four year period, beginning in December 2015, Defendant Barbera sold shares of Nanobeak to 37 investors, raising about $3.6 million using false statements. Specifically, potential investors claimed were told that the company was working with scientists at NASA and a nationally recognized research university to develop a sensor to test and detect cancer and drug use. The firm never developed any such technology and approximately 45% of the investor funds were diverted to the personal use of Mr. Barbera. The complaint alleges violations of Securities Act Section 17(a) and Exchange Act Section 10(b). The case is pending. See Lit. Rel. No. 2497i8 (Dec. 9, 2020).

Procedures – pricing: In the Matter of Ice Data Pricing & Reference Data, LLC, Adm. Proc. File No. 3-2164 (Dec. 9, 2020) is an action which names the registered investment adviser as a Respondent. Over the last five years, beginning in 2015, the firm provided global securities pricing, evaluations and other information to advisory clients through subscriptions. For certain categories of fixed-income securities the firm could not provide a valuation. In those instances, it furnished a quote obtained from a single source. While the firm had compliance procedures which addressed what the question of single source quotes, the policies and procedures were not reasonable. The Order alleges violations of Advisers Act Section 206(4). Respondent resolved the matter by consenting to the entry of a cease-and-desist order based on the section cited in the Order and to a censure. In addition, Respondent agreed to pay a penalty of $8 million which was transferred to the U.S. Treasury.

False statements: In the Matter of Covia Holdings Corp., Adm. Proc. File No. 3-20163 (Dec. 8, 2020) is an action which names the firm, a publicly traded company listed on the NYSE, and Fairmount Santrol Holdings, Inc. (now Bison Merger Sub I, LLC), a provider of products used in the fracking process. The two firms have now merged. Over a four year period, beginning in 2014, Fairmount provided products used in oil and gas exploration and production for fracking based on false claims. In an IPO in 2014, and two follow-on offerings in 2016, misrepresentations were made about the products sold by Fairmount, claiming falsely essentially that they facilitated the fracking process. They did not. Yet in the IPO about $400 million was raised while another $438 million was raised in the two follow-on offerings based on the misrepresentations. The Order alleges violations of Securities Act Sections 17(a)(2) and (3) and Exchange Act Section 13(a) and the related rules. To resolve the matter Respondents consented to the entry of a cease-and-desist order based on the sections cited in the Order. In addition, Respondents will pay a penalty of $17 million on a joint and several basis which will be deemed satisfied by a cash payment from Covia in the amount of $1 million under its Chapter 11 confirmation plan.

Trade allocations: In the Matter of Bluecrest Capital Management Ltd., Adm. Proc. File No. 3-20162 (Dec. 8, 2020) is a proceeding which names the a respondent the former registered investment adviser. In 2011 BlueCrest created a leveraged proprietary fund, BSMA, to trade for the personal capital of its personnel. The largest capital allocations were always to Rates and Relative Value strategies. The firm transferred the personnel who had traded Rates and RV strategies to BSMA. Additional traders were retained who could trade for BSMA only. From 2011 through late 2015 the majority of the highest-performing Rates and RV traders were allocated to BSMA. In addition, BlueCrest replaced the capital allocations of the transferred traders by allocating a substantial amount of BlueCrest Capital International capital to the transferred traders, although the amounts generally were below those of Rates and RV. The capital allocations from the trading program to BVI over a three-year period, beginning in 2012, ranged from about 17% to 51% of BCI’s total allocated capital. Respondent failed to properly disclose each of these steps. The Order alleges violations of Securities Act Sections 17(a)(2) and 17(a)(3) and Advisers Act Sections 206(2) and 206(4). Respondent resolved the proceedings by consenting to the entry of a cease-and-desist order based on the Sections cited above and a censure. In addition, Respondent will pay disgorgement of $107,560,200, prejudgment interest of $25,154,306 and a penalty of $37,285,494. A fair fund was created.

Share class selection: In the Matter of Bancwest Investment Services, Inc., Adm. Proc. File No. 3-20161 (Dec. 7, 2020) is a proceeding which names as a respondent the dual registered investment adviser, broker-dealer. Over a two-year period, beginning in 2014, Respondent purchased, recommend or held for advisory clients shares which carried 12b-1 fees without making the proper disclosures. In resolving the matter, the firm undertook remedial efforts. The Order alleges violations of Advisers Act 206(2) and 206(4). To resolve the case the firm consented to the entry of a cease-and-desist order based on the sections cited in the Order and to the entry of a censure. The firm will also pay disgorgement of $286,450, prejudgment interest of $44,982 and a penalty of $75,000. A fair fund was created. The firm will also comply with certain undertakings.

Offering fraud/COVID-19: SEC v. Applied BioSciences Corp., Civil Action No. 24977 (S.D.N.Y.) is a previously filed action against the firm. The complaint alleged that the firm attempted to sell COVID test kits to individuals for home use based on a finger prick test. Contrary to the press release announcing the sale, the tests could only be administered by a medical professional. The press release also did not disclose that the FDA had not approved the tests. To resolve the matter the firm consented to the entry of a judgment, entered by the Court, which enjoined it from future violations of Exchange Act Section 10(b). The order also directed the firm to pay a penalty of $25,000. See Lit. Rel. No. 24977 (Dec. 7, 2020).

False statements: In the Matter of The Cheesecake Factory Incorporated, Adm. Proc. File No. 3-20158 (December 4, 2020). Cheesecake Factory is a well-known national restaurant chain based in Calabasas Hills, California. The firm’s shares are traded on Nasdaq Global Select Market. As the pandemic began to unfold Cheesecake Factory and other restaurant chains effectively had their businesses closed by the initial restrictions imposed which were designed to try and contain the virus. By mid-March 2020 Cheesecake Factory and others faced unprecedented challenges. Over the next month Cheesecake Factory took a series of steps to try and survive. Those included: 1) Efforts to conserve cash such as a March 18, 2020 letter sent to landlords saying that it would not be paying April rent, an event later reported in the media; 2) by March 23 the company was actively seeking additional liquidity through either debt or equity; possible private equity investors were told the company would survive at the current negative cashflow rate for about 16 more weeks – documents reflected a negative cash flow rate of $6 million per week; 3) a March 23 Form 8-K stated that the company was withdrawing prior financial guidance and moving to an “off-premise model” or delivery model was being installed to permit the firm to operate “sustainably;” 4) a March 27, 2020 Form 8-K stated the company was not planning to pay rent in April, that executive officers, board members and certain employees would take a pay cut and 41,000 workers were furloughed but allowed to retain certain benefits; 5) an April 3, 2020 Form 8-K filing attached an April 2 press release disclosing preliminary Q1 2020 sales noting that the restaurants were operating sustainably using the off-premises model; and 6) on April 20, 2020 Cheesecake Factory announced a $200 million subscription agreement for the sale of convertible preferred stock to a private equity investor. The Order alleges that the March 23 and April 3 Forms 8-K were false and misleading. The filings did not disclose that the firm was “excluding expenses attributable to corporate operations” from its discussions of “sustainability;” there was no statement that the negative cash flow was $6 million per week or only 16 weeks of cash remained as was stated to certain potential lenders. The Order alleges violations of Exchange Act Section 13(a). The firm, whose cooperation was considered by the Commission, resolved the matter, consenting to the entry of a cease-and-desist order based on the sections cited in the Order. The firm also agreed to pay a penalty of $125,000 that was transferred to the U.S. Treasury.

Hong Kong

Consultation: The Securities and Futures Commission announced on December 11, 2020 a consultation on proposals to update its entry requirements for license applications and competency standards for individual practitioners. Under the proposals minimum academic qualifications requirements would be raised and a range of qualifications recognized (here).

Data storage: The SFC released additional guidance for market participants on external electronic data storage on December 10, 2020 (here).


FinTech: The Monetary Authority of Singapore and the Magyar Nemzeti Bank announced on December 9, 2020 the signing of a cooperation agreement to strengthen cooperation in FinTech innovation between Singapore and Hungary (here).

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