This Week In Securities Litigation (Week of March 2, 2020)

The Supreme Court will hear oral argument in Liu v. SEC, No. 18-1501 on Tuesday, one of the most significant cases for the Commission in years. The central question is whether the agency can request and recover disgorgement. Petitioners phrase the issue this way: “Whether the Securities and Exchange Commission may seek and obtain disgorgement from a court as ‘equitable relief’ for a securities law violation even though this Court has determined that such disgorgement is a penalty.” The SEC approaches the issue differently: “Whether a district court, in a civil enforcement action brought by the Securities and Exchange Commission, may order disgorgement of money acquired through fraud.” The case is previewed here.

The resolution of the case may hinge on the fact that neither the Exchange Act nor the Securities Act contains an express provision authorizing the Commission to recover disgorgement. Yet other statutes do provide for such a remedy.

Last week the Commission brought a series of cases which, for the most part, focused on retail investors. Those included actions based on undisclosed conflicts, offering frauds, financial fraud and the failure of an audit firm to adopt proper quality control standards as required by the AICPA.


Whistleblowers: The Commission awarded over $7 million to a whistleblower who provided assistance that proved to be critically important to the success of an enforcement action.

SEC Enforcement – Filed and Settled Actions

The Commission filed 3 civil injunctive action and 4 administrative proceeding last week, exclusive of 12j and tag-along actions, discussed below.

Financial fraud: SEC v. Scana Corporation, Civil Action No. 3:20-cv-0082 (D.S.C. Filed Feb. 27, 2020) is an action which names as defendants the South Carolina operator of a power firm, two of its affiliates and two officers. The action centers on efforts to construct two new nuclear units beginning in 2013. Essentially the firm reported to the public that the program was on track and would be successful. During the period the false statements bolstered the firm’s stock price, aiding the sale of $1 billion in corporate bonds at favorable rates. Internally, however, the firm knew that the projects were struggling and that they would not make the deadline to obtain about $1.4 billion in federal tax credits. The fraud was uncovered in 2017 with devastating consequences for the firm’s investors and customers. Investors lost hundreds of millions of dollars; the energy customers lost over $1 billon in higher rates Scana justified based on the claimed success of the transaction.

Conflicts: In the Matter of Sica Wealth Management LLC, Adm. Proc. File No. 5453 (Feb. 27, 2020) is a proceeding that names as respondents the registered investment adviser and its principal, Jeffrey C. Sica. Over a two-year period, beginning in October 2013, Respondents failed to disclose material conflicts when recommending investments in Aequitas securities (a firm affiliated with several Aequirtas entities). At the time Respondents were receiving about $2 million from Aequitas in undisclosed fees thereby violating Advisers Act Section 206(2). To resolve the matter each Respondent consented to the entry of a cease and desist order based on the section cited in the Order. The firm, after agreeing to implement certain undertakings, consented to the entry of a censure and agreed to pay disgorgement of $236,029.19 and a penalty of $80,000. Mr. Sica agreed to pay a penalty of $30,000.

Conflicts: In the Matter of Fortress Investment Management, LLC, Adm. Proc. File No. 3-19715 (Feb. 27, 2020) is a proceeding which names as respondents the investment adviser which is controlled by Respondent William Malloy’s marital trust. Mr. Malloy also controls MWM 1835 LLC, a registered adviser at one point, and Income Opportunity Capital, LLC, now liquidated, that invested in private credit strategies, including Aequitas securities. In 2014 MWM registered with the Commission as an investment adviser, representing it would have the required regulatory assets within 120 days. In fact, the firm failed to meet the deadline. During the same period Respondents had about $2.6 million in investments in Income Opportunity Capital. During the period Aequitas was paying Fortress a monthly fee for consulting and business development services that included introducing prospective investors to Aequitas. That conflict of interest was not disclosed. The Order alleges violations of Advisers Act Sections 203A and 206(2). To resolve the proceedings, Mr. Malloy consented to the entry of a cease and desist order based on the sections cited in the Order. He was suspended from the securities business for 12 months, prohibited from serving with an investment adviser for the same period and agreed to pay a $50,000 penalty. Fortress consented to the entry of a cease and desist order based on Advisers Act Section 206(2) and agreed to pay a penalty of $50,000 along with disgorgement of $45,040 and prejudgment interest of $9,057.

Custody rule: In the Matter of Steven E. Fishman, Adm. Proc. File No. 3-19713 (Feb. 27, 2020) is a proceeding which names as a respondent the co-founder of Formation Capital, LLC, a registered investment adviser. Respondent has been expected to invest in each of the single-purpose funds managed by Formation Capital. When Respondent could not fund his contributions he solicited other investors to assist him by making contributions to a series of entities used for that purpose. That conduct was prohibited by the firm. This resulted in the failure of the funds to have audited financial statements as required by the Custody Rule. The Order alleges violations of Advisers Act Section 206(4) and the related rule. To resolve the matter Respondent consented to the entry of a cease and desist order based on the section cited in the Order. He also agreed to be barred from association with any adviser with the right to apply for re-entry after 5 years. He will pay a penalty of $50,000.

Audit – polices: In the Matter of RSM US LLP, Adm. Proc. File No. 3-19710 (Feb. 26, 2020). Respondent is a Chicago based audit and advisory firm registered with the PCAOB. The firm provides audit, tax and consulting services. SBB Research Group, LLC is a registered investment adviser that has provided advisory services to Private Funds since 2011. Those funds invested largely in structured notes that were generally tied to the performance of the S&P Index and the Russell 2000 Index. To comply with the Custody Rule SBB retained RSM US to audit each of the Private Funds for the years 2013 through 2017. At the beginning of the engagement the audit firm employed a risk-based model to evaluate the work. The Engagement Partner selected was authorized to work on audit engagements at all risk levels. That Engagement Partner, however, had no prior experience auditing or valuing structured notes. The staff assigned to the engagement had virtually no structured note experience. The RSM audit team failed to properly conduct its work on the Private Funds engagements. In 2013, for example, RSM used an independent estimate approach to test the reasonableness of SBB’s fair value estimates for the notes. The software used by the provider, however, was only approved for valuing Level 1 and 2 assets. The structured notes were Level 3. Since SBB had mischaracterized the notes as Level 2, the audit team, using the provider’s estimates, found the SBB valuations reasonable. In reaching its conclusion, the audit team failed to obtain an understanding of the inputs, methods and assumptions underlying the valuation model as required. The next year the audit team began with the same methodology. This time, however, the variance between the third party estimates and those of SBB exceeded, on a fund level, RSM’s allowable variance for three of the Private Funds – the SBB estimates were uniformly higher. While specialists were requested to assist, they proved to not be qualified to work on structured notes. Eventually, the firm resigned and withdrew its prior opinions. The Oder alleges that Respondent failed to comply with applicable Quality Control standards and violated Rule 102(e)(1)(ii) of the Rules of Practice. In resolving the matter RSM agreed to implement a series of undertakings regarding its Quality Control policies and procedures. Those included a remediation plan and a requirement to obtain a remediation certification. The Commission sanctioned Respondent, entering a censure, and directed that RSM comply with its undertakings.

Unregistered broker: SEC v. Fierro, Civil Action No. 3:20-cv-02104 (D. N.J. Filed Feb. 26, 2020) is an action which names as defendant John D. Fierro and his firm, JDF Capital, Inc. The action centers on the repurchase of convertible notes by Defendants from microcap issuers and the subsequent resale of the securities after the conversion of the notes. Specifically, over a two year period, beginning in January 2015, Defendants purchased 50 convertible notes from different issuers, converted them and sold the unregistered shares, securing about $2.3 million in profits. Defendants are not registered broker dealers. The complaint alleges violations of Exchange Act Sections 15(a)(1) and 20(a). The case is pending. See Lit. Rel. No. 24748 (Feb. 26, 2020).

Offering fraud: SEC v. Van Zyle, Civil Action No. 1:20-cv-00836 (N.D. Ga. Filed Feb. 25, 2020) is an action which names as a defendant Dionne Van Zyle, an elder at an Atlanta based church. Defendant solicited members of his church to invest with him over a period of years beginning in 2013. Specifically, about 35 clients invested about $23.5 million. The funds were put into start-up companies that Defendant owned and controlled, at times in high-frequency forex trading and at other times in an unregistered investment company Mr. Van Zyle controlled. Investors were not properly informed about the investments or the amount of fees taken by Mr. Van Zyle. The complaint alleges violations of each subsection 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 in litigation. See Lit. Rel. No,. 24747 (Feb. 26, 2020).

Criminal Cases

Manipulation: U.S. v. Herod (D. Conn. Sentencing Feb. 20, 2020). Jay Herod implemented a scheme to manipulate the shares of Boston based PixarBio Corp. in 2016. In December he engaged in a series of trades that were designed to mimic trading activity in the market. The trades – matched orders – create the appearance of activity in the market for the particular shares of stock. That type of activity can draw the attention of other traders and market participants to the stock. The result is an increase in trading volume and price. Mr. Herod also utilized another fraudulent technique designed to push up the price called marking-the-close. This approach is implemented by making a series of small buys and sells in the waning minutes of the trading day prior to the market close. Overall the impact is to typically create artificial market activity which pushes up the price by the time the market closes for the day. Two years after implementing the scheme the SEC investigated the trading. Mr. Herod made materially false statements to the investigators during the course of their investigation. He also submitted a back-dated document to the Commission staff with the intent of obstructing the inquiry. Mr. Herod was charged, along with the President of PixarBio, with counts that included stock manipulation. Mr. Herod pleaded guilty to one count of securities fraud and one count of obstruction of an agency proceeding. He then elected to cooperate with the Government. President elected to proceed to trial. He was convicted by a jury. On February 20, 2020 Mr. Herod was sentenced to serve six months in prison followed by three years of supervised release. He was also directed to pay forfeiture/restitution of $120,000. President was previously sentenced to serve seven years in prison. The complaint alleges violations of each subsection of Securities Act Section 17(a) and Exchange Act Sections 13(a) and 10(b). The case is in litigation. See Lit. Rel. No. 24751 (Feb. 27, 2020).


Remarks: James Shipton, Chair, Australia Securities and Investments Commission, Corporations and Financial Services, delivered the opening statement at the Parliamentary Joint Committee (Feb. 28, 2020). His remarks focused on a review of the work by the ASIC, the renewed governance and accountability framework the strengthening of risk management and their response to pandemic events (here).

Tagged with: , , ,