This Week In Securities Litigation (Week of February 27, 2023)
The Commission filed cases last week centered on insider trading, financial fraud, corporate controls, Regulation M Rule 105 and microcap fraud. A new report by Cornerstone Research found that the number of enforcement actions filed by the PCAOB last year increased significantly over the prior year.
Be careful, be safe this week.
SEC Enforcement – Filed and settled actions
During the last week the Commission filed 5 new civil injunctive actions and 2 new administrative proceedings, exclusive of 12j, default, conflicts (which are included in tabulating the number of cases), tag-a-long and other similar proceedings.
Insider trading: SEC v. Stiles, Civil Action No. 1:23-cv-01523 (S.D.N.Y. Filed February 23, 2023) is an action which names as defendants two cousins, James Andrew Styles and Edward Gary Stiles. James Andrew was employed at BDO USA, LLP as the Managing Director in the Biodefense & Government Contracts group until May 2020. Subsequently, he was employed by Phlow Corporation, a pharmaceutical company, as V.P. of Government Initiatives and Contract Compliance. Phlow was assisting Eastman Kodak Company in obtaining funding from the federal government to produce medicines focused on responding to the COVID-19 pandemic. While the funding was being negotiated, but before the information became public, James Andrew purchased Kodak stock. After the government’s interest in Kodak was disclosed, the shares were sold for $553,000. He also tipped his cousin Edward Gary Stiles who purchased shares. After the information became public the shares sold for about $990,000. While employed by BDO, James Andrew worked on matters for Novavax, a firm with a consulting contract with BDO. The company was attempting to procure over $300 million in funding to support efforts in developing a coronavirus vaccine. Before this information was disclosed James Andrew purchased shares of Novavax which were sold after the information became public. He had profits of over $45,000 on the transaction. The complaint alleges violations of Exchange Act Section 10(b). The case is pending. The U.S. Attorney’s Office for Manhattan announced parallel criminal charges. See Lit. Rel. No. 25647 (February 23, 2023).
Financial Fraud: SEC v. Ozy Media, Inc., Civil Action No. 23 Civ. 1424 (E.D. N.Y. Filed February 23, 2023) is an action which names as defendants: the firm, a start-up news and media company; Carlos R. Watson, Jr., formerly a registered representative, an attorney who does not practice and the CEO of Ozy; Samir Rao, formerly a registered representative and currently the COO of Ozy; and Suzee Han, chief of staff at Ozy. Over a three-year period, beginning in 2019, Defendants Watson and Ray, with assistance from others, provided materials and pitchbooks about Ozy which overstated historical, annual revenues by at least 100%. Investors were, in addition, repeatedly told that large, significant, sophisticated investors were about to put funds in the company – a false statement. In February 2021 Defendant Rao, in addition, impersonated a You Tube executive on a conference call in an effort to embellish Ozy’s business relation with You Tube and obtain a $25 million investment. Later the impersonation was reported in the New York Times. The complaint alleges violations of each Subsection of Securities Act Section 17(a) and Exchange Act Section 10(b). Defendant Rao consented to the entry of a judgment enjoining him from violating the provisions charged in the complaint and precluding him from serving as an officer/director for ten years. Defendant Han agreed to a similar entry. Monetary penalties will be determined for each defendant at a later date. The U.S. Attorney’s Office for the Eastern District of New York announced the filing of criminal charges as to each individual Defendant.
Controls: In the Matter of African Gold Acquisition Corp., Adm. Proc. File No. 3-21309 (February 22, 2023) is an action which names as Respondent a publicly traded SPAC formed in the Cayman Islands and based in New York City. Its primary asset, as of March 31, 2021, was a bank account that held $1.5 million. Despite this fact the firm lacked effective internal controls over the account. For example, it failed to establish sufficient segregation of duties and monitoring controls over the operating bank account. The firm also failed to reconcile the bank account activity. These failures permitted the firm’s former CFO to misappropriate most of the liquid assets. Indeed, the former employee took about $1.2 million while selectively determining which vendors to pay or not pay to facilitate not getting caught. The thefts were also aided by the fact that virtually all authority over the internal controls had been delegated to the former CFO. And, management failed to test the effectiveness of the existing controls. Ultimately, African Gold failed to disclose the amount of the losses in its Form 10-K filed for year-end 2021 with the Commission. The Order alleges violations of Exchange Act Sections 13(a), 13(b)(2)(A), 13(b)(2)(B) and the related rules. Respondent resolved the proceedings, consenting to the entry of a cease-and-desist order based on the provisions cited in the Order. The firm will also pay a penalty in the amount of $103,591.
Rule 105: SEC v. Candlestick Capital Management, Civil Action No. 3:23-cv-00206 (D. Conn. Filed February 17, 2023). Candlestick Capital Management LP is a Commission registered investment adviser. The advisor has about $3 billion in assets under management. The complaint involving the advisor focuses on June 2020. In that period the advisor sold short 350,000 shares of American Airlines common stock. The average price was $17.622891. Four days after the short sale American Airlines filed a preliminary prospectus. It supplemented an existing shelf registration for a follow-on offering of common stock to be priced after the market close on June 22, 2020. The same day the advisor recognized that the Funds’ June short sale fell within the Offering Period of Rule 105. The next day the advisor received an allocation of American Airline stock of 750,000 shares. Rule 105 was adopted to ensure that secondary and follow-on offerings are priced independently and not manipulated. Accordingly, the rule prohibits the purchase of equity securities from an underwriter, broker or dealer participating in a covered public offering if the buyer sold short the same security during a restricted period absent an exception. The period begins five business days before the pricing of the offered securities and ends with the pricing. Alternatively, it begins with the initial filing of a registration statement or notification on a designated Exchange Act Form and ends with the pricing. The rule is not based on intent but mechanics and dates. A bona fide purchase exception provides an exemption to the prohibition of the rule as long as the same security is purchased in at least the same amount and sold short during the restricted period. The purchase must also be made during regular trading hours, reported to an effective transaction reporting plan and meet certain other requirements that are designed to foster transparency of the activity to the market. That permits the effects of the purchase to be reflected in the security’s market price prior to the pricing of the offering. Here Candlestick did not qualify for the exception. After concluding that it violated Rule 105 Candlestick did not self-report to the Commission. The firm also did not accurately document the Rule 105 violation in its books and records. It did admit the violation to the inspection staff, but only after a direct question was asked. The Candlestick has undertaken remedial acts. The complaint alleges violations of Regulation M. Defendant resolved the action, consenting to the entry of a final judgment ordering it to pay a penalty of $810,000. It also agreed to the entry of an order directing the payment of disgorgement in the amount of $1,565,305 and interest of $89,439. In a separate administrative proceeding the firm consented to the entry of a cease-and-desist order based on Rule 105. See Lit. Rel. No. 25642 (February 21, 2023); See also SEC v. Hite Hedge Asset Management, Civil Action No. 1:23-cv-109351 (D. Mass. Filed February 17, 2023)(similar action).
Microcap fraud: SEC v. Sharp, Civil Action No. 1:21-cv-11276 (D. Mass.) is a previously filed action which names as defendants William Kaitz, Graham Taylor and others. The action centers on a scheme that began in 2011 and continued through at least 2019. Defendant Fredrick Sharp created a scheme which engaged others to conceal the control and ownership of large amounts of stock and then dump it on the U.S. markets. Defendants Taylor and Sharp settled with the Commission. Each consented to the entry of a permanent injunction based on Securities Act Section 17(a) and Exchange Act Section 10(b). Defendant Taylor also agreed to pay disgorgement of $3,432,412, prejudgment interest of $1,285,272 and a penalty of $207.183. Defendant Sharp agreed to pay disgorgement of $812,854, prejudgment interest of $279,014 and a penalty of $215,000. Both judgments impose penny stock bars. The Court had previously entered a judgment by default against Defendant Sharp that ordered him to pay over $50 million. Other Defendants continue to litigate. See Lit. Rel. No. 25644 (February 21, 2023).
Insider trading: SEC v. Van De Grift, Civil Action No. 23-cv-01491 (S.D.N.Y. Filed February 22, 2023) is an action which names as defendants Devin A. Van De Grift and his friend Gil Friedman. Defendant Van De Grift was a day trader; his friend, Defendant Friedman, was employed as a consultant for Francisco Partners, which was negotiating to acquire Verifone Systems, Inc. He told his friend Defendant Van De Grift about the proposed transaction in early March 2018, prior to the deal announcement and after participating in a phone call about the transaction with an employee of Verifone. Defendant Van De Grift purchased 60,000 of company stock, valued at about $1 million. The deal was announced on April 9, 2018. The share price increased about 52%. The complaint alleges violations of Exchange Act Section 10(b). The case is pending. See Lit. Rel. No. 25645 (February 23, 2023).
Fraudulent microcap scheme: SEC v. Back to Green Mining, LLC, Civil Action No. 3-21-cv-01455 (D. P.R.) is a previously filed action which named as defendant the company and two managing members, Jimenez Cruz and Manuel Portalatin. Defendants are alleged to have sold shares in an unregistered offering that was part of a fraudulent scheme conducted by placing advertisements in publications offering huge profits while representing that all permits for the company had been obtained. The claims were false. The firm and Defendant Jimenez resolved the matter, consenting to the entry of permanent injunctions based on Securities Act Sections 5(a), 5(c) and 17(a) and Exchange Act Section 10(b). Defendant Jimenez was also enjoined from participating in any offering not registered with the agency. Defendants were ordered to pay, on a joint and several basis, disgorgement of $1,995,538 and prejudgment interest of $410,728. The company and Defendant Jimenez were also directed to pay penalties of, respectively, $1,035,909 and $207,183. See Lit. Rel. No. 25646 (February 23, 2023).
Enforcement results: Cornerstone Research published a report on Board enforcement activity titled Public Company Accounting Oversight Board Enforcement Activity, 2022, Year in Review. The report found that the Board disclosed 29 enforcement actions last year against 26 individual and 17 firms, an increase of 60% over the prior year (here).
Newsletter: The European regulator published its Spotlight on Markets Newsletter (February 22, 2023), the latest edition of its publication which focuses on key events in the markets (here).
Consultation: The Hong Kong Securities and Futures Commission launched a consultation on proposals to regulate virtual asset trading platforms, according to a release dated February 20, 2023 (here).
MOU: The Hong Kong regulator announced an MOU with CSRC on regulatory cooperation dated February 17, 2023 (here).
Due diligence: The Monetary Authority of Singapore imposed Due Diligence Requirements for Corporate Finance Advisers, in a release dated February 23, 2023 (here).