This Week In Securities Litigation (Week of July 19, 2021)
Last week Chair Gensler announced the members of his new Policy Team. The reason for creating the group is unclear, particularly since in some instances the titles given to the members of the new group overlap those of others at the agency.
Two Commissions continued to proffer the idea of creating some kind of safe harbor for new crypto assets. The proposal apparently envisions a period during which new crypto assets would not have to comply with security law disclosures. The point of this proposal is also unclear.
Be careful, be safe this week
Staff: Chair Gensler announced the members of his Policy Team. The team members are: Corey Klemmer, Corporation Finance Counsel; Adam Large, Trading and Markets Counsel; Mika Morse, Climate Counsel; Sirimal Mukerjee, Investment Management Counsel; and Sal Rao, Trading and Markets Counsel.
Statement: Commissioners Hester M. Peirce and Elad L. Roisman issued a statement supporting the creation of a safe harbor for crypto assets on July 14, 2021 (here). Comment on the proposal is available here.
SEC Enforcement – Filed and Settled Actions
Last week the Commission filed 7 civil injunctive actions and 9 administrative proceedings, exclusive of tag-along and other similar proceedings and 2 actions in which the author is involved.
Manipulation: SEC v. Muller, Civil Action No. 1:21-cv-06048 (S.D.N.Y. Filed July 14, 2021) is an action which names as a defendant Marlon Muller who was previously named in a private lawsuit alleging he manipulated a market in Florida. Beginning in June 2015 Mr. Muller is alleged to have used an internet chat application and instructed an Associate on when and how to purchase and sell shares of EMS Find, Inc., a microcap issuer. The purpose was to achieve certain price and liquidity levels for the shares. The trading distorted the price. Defendant received at least $65,000 from Associate in compensation for his role in the scheme and another $265,000 from an entity that knowingly purchased EMSF shares from Defendant Mueller and Associate during the scheme. During the same period 1,500 retail accounts, including 300 individual retirement accounts, invested over $1 million in the stock. Following the termination of the manipulation the share price dropped leaving those accounts with losses. The complaint alleges violations of Securities Act Sections 17(a)(1) and (3) and Exchange Act Sections 9(a)(2) and 10(b). The case is pending. See, Lit. Rel. No. 25143 (July 15, 2021).
Offering fraud: SEC v. Gordon, Civil Action No. 3:21-cv-01642 (July 15, 2021) is an action which names as defendants: Jefferey Gordon; Blue Rock Ventures, LLC; and Windy City Accelerated Returns Venture I, LLC. Mr. Gordon controls each of the entity defendants. He is also a securities law recidivist, having been enjoined earlier in a Commission enforcement action. Over a two year period, beginning in 2018, Mr. Gordon sold interests in Windy City to investors. The proceeds were then used to promote interests in Blue Rock. Mr. Gordon told investors that Blue Rock had interests in rental properties, that all interests were rented and that the expected returns would be 250% to 350%. In fact, Blue Rock did not own rental properties. Rather, Defendants misappropriated the investor funds. 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. 25142 (July 15, 2021).
Financial fraud: SEC v. Palleschi, Civil Action No. 2:21-cv-00530 (M.D. Fla. Filed July 15, 2021) is an action which names as defendants Michael Palleschi and David Lethem. Each defendant is a senior executive at FTE Networks, Inc., a Naples-based public company that provides network infrastructure to the technology and telecommunications industries. Over a three year period, beginning in 2016, the two executives engaged in three fraudulent schemes. First, they issued about $22.7 million in complex convertible notes. Since the conversion feature which permitted the notes to convert to stock was so complex, Defendants concealed it. Second, Defendant inflated FTE’s revenues by inventing about $12.5 million in revenue purportedly from completed construction projects that had not yet been billed but for with the company supposedly had completed the work. The claims were false since the work had not been done. Third, Defendants misappropriated about $5.4 million form the company for their personal use. Eventually the fraudulent acts were uncovered by an independent director. FTE was required to restate its financial statements. The complaint alleges violations of each provision of Securities Act Section 17(a) and Exchange Act Sections 10(b), 13(a), 13(b)(2)(A), 13(b)(2)(B), 13(b)-5, 14(a) and SOX Section 304 along with related rules. The case is pending. See Lit. Rel. No. 25141 (July 15, 2021). See also the parallel criminal case discussed below.
Conflicts: In the Mater of Cascade Investment Group, Inc., Adm. Proc. File No. 3-20396 (July 14, 2021) is an action against the dual registered broker-dealer and investment adviser. Over a five year period, beginning in October 2014, Respondent was paid 12b-1 fees on mutual funds in transactions with clients without disclosing that fact. The firm also failed to properly implement compliance procedures regarding such conflicts. The Order alleges violations of Advisers Act Sections 206(2) and 206(4). In resolving the matter, the firm agreed to implement a series of undertakings. It also consented to the entry of a cease-and-desist order based on the Sections cited in the Order and agreed to the entry of a censure. In addition, the firm will pay a penalty of $125,000.
Revenue recognition: In the Matter of Paul L. Chancey, Jr. CPA, Adm. Proc. File No. 4225 (July 13, 2021) is a proceeding which names as a respondent Mr. Chancey, a certified public accountant and a partner in the Georgia firm of Cherry Bekaert, LLP. During the audits of MiMedxGroup, Inc. for 2015 and 2016 Respondent became aware that portions of the firm’s revenue was contingent. For 2015 Respondent also learned from the controller that revenue was recognized prematurely; for 2016 he learned the same fact with regard to the revenue from a vendor. In both instances Mr. Chancey ignored the warnings. His opinion incorrectly stated that the audits had been done in accord with PCAOB standards. The Order alleges violations of Rule 102(e). The proceedings will be set for hearing.
Conflicts: In the Matter of TIAA-Cref Individual & Institutional Services, LLC, Adm. Proc. File No. 3-20392 (July 13, 2021) is a proceeding which names the registered investment adviser and broker-dealer as Respondent. The proceedings center on a failure to adequately disclose conflicts of interest and the distribution of false statements in connection with recommendations that clients invest in Teachers Insurance and Annuity Association of America (TIAA) record-kept employer-sponsored retirement plans or ESP roll over retirement assets into a managed account program called Portfolio Advisor. Over a five year period, beginning in January 2013, Respondent created positive incentives and negative pressures for its Wealth Management Advisors to roll over ESP assets into Portfolio Advisor. In connection with this process Respondent and WMAs also made misleading statements to induce clients to execute the rollover. Respondent also failed to properly disclose related conflicts resulting from incentive compensation and failed to properly implement its applicable policies and procedures. The Order alleges violations of Securities Act Sections 17(a)(2) and (3). In resolving the matter Respondent took certain remedial acts. The firm also consented to the entry of a cease-and-desist order based on the Sections cited in the Order and to a censure. In addition, Respondent will pay disgorgement of $73,985,572, prejudgment interest of $14,014,428 and a penalty of $9 million. A fair fund is created for the penalties. The Order also states that the disgorgement and prejudgment interest does not exceed Respondent’s net profits from the violations.
Binary options: SEC v. Mimun, Civil Action No. 2:21-cv-01314 (July 12, 2021) is an action which names as defendants Jonathan Mimun and Ronn Benharav. Defendants are two citizens of Israel who owned internet brokers Porter Finance and Dalton Finance. They also owned a boiler room known as JMRB Media, Ltd. Using these vehicles Defendants sold millions of dollars of fraudulent binary options to U.S. investors over a five year period, beginning in 2013. The boiler room was used to solicit investors to purchase the options. The Porter Brokers, which made money through investor losses, operated through a number of websites, call centers and straw companies that held bank and credit card processing accounts to facilitate the scheme. The sales pitch explained that the solicitor was an experience broker and that investors would make money. The statements were false. The securities were not registered. The complaint alleges violations of Securities Act Sections 5 and 17(a)(1) and (3) and Exchange Act Sections 10(b) and 20(a). The case is pending. See Lit. Rel. No. 25140 (July 13, 2021).
Offering fraud: SEC v. Rosenfeld, Civil Action No. 1:21-cv-03902 (E.D.N.Y. Filed July 12, 2021) is an action which names as a defendant attorney Shimon Rosenfeld. Over a four year peruid attorney Rosenfeld solicited at least five investors who invested about $6 million in what they were told were real estate ventures. In fact, Mr. Rosenfeld misappropriate the funds. The complaint alleges violations of Securities Act Section 17(a) and Exchange Act Section 10(b). The case is pending. See Lit. Rel. No. 25139 (July 12, 2021).
Insider trading: SEC v. Watson, Civil Action No. 1:21-cv-05923 (S.D.N.Y. Filed July 9, 2021) is an insider trading case that names as defendants Eric Watson, Oliver-Barret Lindsay and Gannon Giguiere. Mr. Watson was the controlling shareholder and a corporate insider of Long Island Iced Tea Corporation, now known as Long Blockchain Corporation. He is also a securities law recidivist, having settled insider trading charges with the Commission in 2001 and pleaded guilty to a conspiracy charge in a manipulation case in 2019. Defendant Lindsay is a Canadian citizen who is an exempt broker registered in the Cayman Islands. Defendant Gannon Giguiere is a friend and associate of Mr. Watson. Both men were charged by the Commission in 2016 with market manipulation. In late 2017 Defendant Watson told Mr. Lindsay that Long Island Iced Tea was planning to change its name and line of business. The announcement was to be issued shortly. Subsequently, on December 20, 2017 Mr. Lindsay told his friend, Defendant Giguliere, that Long Island Iced Tea planned to change its name to its current form. In connection with the renaming, the company planned to remake itself and its line of business. Within hours of the conversation Mr. Giguiere purchased 35,000 shares of Long Island Iced Tea stock. The next day the company published an announcement stating the going forward the firm would engage in a new line of business. Specifically, the announcement stated in part that Long Island Iced Tea was “shifting its primary corporate focus toward the exploration of and investment in opportunities that leverage the benefits of blockchain technology . . .” The firm also planned to change its name to Long Blockchain Corporation, according to the December 21, 2017 announcement. Following the announcement, the firm’s share price increased by 388% compared to the prior day’s close on large volume. Two hours after the announcement Mr. Giguiere sold all of his Long Island Ice Tea shares, reaping $162,500 in illicit profits. The complaint alleges violations of Exchange Act Section 10(b). The case is pending. The Commission also revoked the registration of the company under Exchange Act Section 12j.
Insider trading: SEC v. Trovias, Civil Action No. 1:21-cv-05925 (S.D.N.Y. Filed July 9, 2021) is an insider trading case. Defendant Apostolos Trovias is a citizen of Greece. His last known residence is in that country. Since 2016 he has maintained vendor accounts on several Dark Web marketplaces where he is known as The Bull. Beginning in 2016, and continuing until 2021, Mr. Trovias offered to and did sell what he claimed was inside information on the dark web. In part, The Bull claimed his tips came from order-book data from a securities trading firm. The statement was either false and misleading or, if true, a violation of his obligations in handling inside information. The market book tips were marketed through weekly and monthly subscriptions and as one-off assets. Mr. Trovias had over 100 subscriptions. Defendant also sold pre-release earnings reports of publicly traded companies. The information was inside information. His customers included undercover Internal Revenue Service and Federal Bureau of Investigation special agents. The complaint alleges violations of Exchange Act Section 10(b). The case is pending. The U.S. Attorney’s Office for the Southern District of New York filed a parallel criminal action.
Conflicts: In the Matter of Kestra Private Wealth Services, LLC, Adm. Proc. File No. 3-20391 (July 9, 2021). Respondent is a registered investment adviser. Since 2014 an Affiliated Broker has received revenue sharing payments from an unaffiliated clearing broker because of investments by Respondent’s advisory clients for which there was no disclosure. In addition, certain mutual funds which paid revenue sharing were selected for clients where the equivalent shares were available without the fees without making the necessary disclosures. Finally, since January 2014 the Affiliated Broker received compensation from transaction fees charged on mutual fund trades and non-transaction fees for certain services provided to advisory clients that were greater than the amount charged to the Affiliated Broker by the Clearing Broker for those trades – that is, fee markups. Again, there was no disclosure. The firm also breached its duty by failing to seek best execution for certain classes of mutual fund shares and properly implement the related compliance procedures. The Order alleges violations of Advisers Act Sections 206(2) and 206(4). To resolve the matter, Respondent agreed to implement certain undertakings and 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. Respondent also agreed to pay disgorgement in the amount of $208,187, prejudgment interest of $31,382 and a penalty of $60,000. See also In the Matter of Kestra Advisory Services, LLC, Adm. Proc. File No. 3-20390 (similar matter resolved with an identical cease-and-desist order and the payment of disgorgement in the amount of $7,229,802, prejudgment interest of $1,272,370 and a penalty of $1.5 million).
Muni bonds: In the Matter of Hiltop Securities, Inc., Adm. Proc. File No. 3-20389 (July 9, 2021) is a proceeding which names as respondents the firm, a registered broker-dealer, investment adviser and municipal advisor, and Daniel Tracy, a registered representative at the firm. The proceeding centered on violations of rules of the Municipal Securities Rulemaking Board regarding priorities in muni bond offerings and Hilltop’s supervisory failures. Specifically, over a two year period, beginning in 2016, the firm failed to give first priority to retail orders as required by the rules and permitted “stock” orders – those from the firms that are rarely filled — to obtain bonds. While Mr. Tracy knew that Hilltop and other stock orders did not qualify to be filled, but in fact they were. This resulted in violations of MSRB Rule G-17. To resolve the matter Respondent Hilltop took certain remedial steps and consented to the entry of a cease-and-desist order based on Exchange Act Section 15B(c)(1) and MSRB Rules G-17 and 27 and to a censure. Mr. Tracy’s activities were limited in certain specific maters tied to future offerings. The firm will pay disgorgement of $206,606, prejudgment interest of $48,587 and a penalty of $85,000. Mr. Tracy will pay a penalty of $25,000.
Audit failures: In the Matter of PlS, CPA, PC, Adm. Proc. File No. 3-19767 (July 9, 2021) is a proceeding which names as Respondents the professional firm and three of its members, Chang Park, Joseph Yongyun Lee and Juchi Lee. The work involved three issuers, none of whom have filed reports with the Commission since 2016: IMKG, Group, Inc., RadTek, Inc., and Therapeutic Solutions International, Inc.. The Order alleges: improper professional conduct based on a failure to prepare and retain required audit documentation; improperly modifying documentation, contrary to PCAOB rules; failing to obtain or perform engagement quality reviews; failing to exercise due professional care; and violating PCAOB Rules 3500T and 4006. The Order alleges violations of Exchange Act Rule 2-02(b)(1) of Regulation S-X and PCAOB Rules 3500T and 4006. To resolve the proceedings each Respondent consented to the entry of a cease-and-desist order from violating the Rules and Regulations cited in the Order. Each Respondent was also denied the privilege of appearing and practicing before the Commission as an accountant with the right to apply for readmission after certain periods: The firm, five years; Park 5 years; Joe Lee 3 years; and Juchi Lee 3 years. In addition, the firm will pay disgorgement of $36,000, prejudgment interest of $1,028.24 and a penalty of $36 million. Each Respondent will pay a penalty in the following amount: Park $38,556; Joseph Lee $19,278.00; and Juchi Lee $19,278.00
Accounting fraud: U.S. v. Palleschi, No. 1:21-cr-00454 (S.D.N.Y. Charges unsealed July 15, 2021) is an action which changes Defendants Michael Palleschi and David Lethem, respectively the former CEO and CFO of FTE Networks, Inc. with conspiracy, securities fraud and wire fraud. The charges are based on a years long scheme to falsely inflate the firm’s revenue, conceal certain liabilities and embezzle company funds. The scheme centered on the issuance of 70 notes for $22 million in 2019 which supposedly could be converted into shares. Defendants concealed the methods by which the notes could be converted. Fake board resolutions were created to help conceal the scheme. Defendants also created false records and lied to the auditors. Ultimately the firm recognized over $3 million is revenue that was improper. See also related SEC action discussed above.
Insider trading: U.S. v. Brown, (N.D. Ca. Filed July 15, 2021) is an action which named as defendants Nathaniel Brown, formerly the senior revenue manager at Infinera Corporation, who furnished material nonpublic information to his friend, Benjamin Wylam, who used it to trade beginning in April 2016 and continuing to 2017. Each man pleaded guilty to one count of securities fraud. The date for sentencing has not been set.
Offering fraud: US v. Rafael, No. 19-cr-20447 (S.D. Fla. Sentencing July 15, 2021) is an action in which Benjamin Rafael previously pleaded guilty in connection with an offering fraud in which he stole about $60 million raised from investors and promoters seeking financing for movies and Broadway plays. In a second action Defendant Rafael, concealed his first conviction when obtaining funds under the paycheck protection program. On both charges the Court sentenced him last week to serve 42 months in prison.
SPACs: The European Securities and Markets Authority published a disclosure and investor protection statement regarding SPACs on July 15, 2021. The notice provides guidance on disclosure and cautions investors that SPACs may not be suitable investment vehicles for everyone (here).
Investor warning: The Securities and Futures Commission of Hong Kong issued a warning statement on unregulated virtual asset platforms on July 16, 2021 (here).
Initiative: The Monetary Authority of Singapore launched a global challenge to accelerate innovation and responsible AI solutions, on July 12, 2021. The competition seeks to accelerate the development of solutions which validate artificial intelligence and data analytics solutions to strengthen trust and promote greater AI applications in the financial sector (here).
Report: The Financial Conduct Authority published its annual Report and Accounts 2020/21 on July 15, 2021. The report looks back on key work done by the regulator throughout the period (here).