This Week In Securities Litigation (Week ending April 24, 2015)
The Department of Justice unsealed criminal charges against a U.K. trader who is alleged to have contributed to the flash crash almost five years ago. The trader is alleged to have manipulated the market for certain instruments on the CME in Chicago.
Actions brought by the SEC this week largely reflect the broken-windows enforcement approach being followed by the agency. They include two stop order proceedings, three offering fraud actions, a proceeding based on MSRB Rules involving a sale to one customer, an action for failing to make filings after going dark for a period, another for not properly preparing reports for the board of trustees of certain funds and one centered on a conflict by a portfolio manger.
SEC
Whistleblowers: The Commission awarded over $1 million to a compliance professional for information that proved beneficial in an enforcement action.
Remarks: Commissioner Michael Piwowar delivered remarks at the University of South Carolina and UNC-Charlotte 4th Annual Fixed Income Conference, Charlotte, N.C. (April 21, 2015). The Commissioner addressed current challenges in the fixed income market (here).
SEC Enforcement – Filed and Settled Actions
Statistics: During this period the SEC filed 0 civil injunctive cases and 9 administrative actions, excluding 12j and tag-along proceedings.
Stop Order: In the Matter of the Registration Statement of International Precious Metals, Inc., Adm. Proc. File No. 3-16511 (April 23, 2015). The Order alleges that the registration statement for the firm, which claims to have one officer and director, is false and misleading because it has not disclosed its officers and directors and control person. The matter will be set for hearing.
Stop Order: In the Matter of the Registration Statement of Kismet, Inc., Adm. Proc. File No. 3-16510 (April 23, 2015) is a proceeding in which the firm claims to be dependent on the efforts of one person. The firm has failed to respond when served with an investigative subpoena on three dates. The subpoena sought the testimony of the sole officer and director. The matter will be set for hearing.
Touting: In the Matter of Huston American Energy Corp., Adm. Proc. File No. 3-1600 (August 4, 2014) is a previously filed action which names in the caption the firm, John Terwilliger, its CEO, and Undiscovered Equities, Inc., a public relations firm, and its President, Kevin McKnight. The Respondents are Undiscovered Equities and Mr. McKnight. The Order alleges that in 2009 Huston American publicized on its website that it had entered into a contract with Undiscovered Equities to increase the awareness of the investment community about Huston American. Other publicity repeated the claim. The amount of compensation was not disclosed. The proceeding was resolved with an undertaking by Mr. McKnight not to enter into any arrangements such as the one here for five years. In addition, each Respondent consented to the entry of a cease and desist order based on the Section cited in the Order. Mr. McKnight will pay a civil penalty of $22,500. Initially Mr. McKnight and Undiscovered Equities were charged in the Order alleging the offering fraud described below.
Offering fraud: In the Matter of Houston American Energy Corp., Adm. Proc. File No. 3-16000 (Filed August 4, 2014) is a previously filed action which initially named as Respondents each person listed in the caption of the action discussed above. In this Order, which is the settlement, only Huston American and Mr. Terwilliger are named as Respondents. The Order alleged an offering fraud as detailed here. Houston American and Mr. Terwilliger resolved the proceeding, consenting to the entry of a cease and desist order based on Securities Act Section 17(a) and Exchange Act Section 10(b) and 20(b). Mr. Terwilliger will pay a civil money penalty of $150,000 while the company will pay $400,000.
Offering fraud: In the Matter of Edward M. Daspin, Adm. Proc. File No. 3-16509 (April 23, 2015) is a proceeding which names as Respondents: Edward Daspin, founder and control person of the companies, Luigi Agostini, a director and COB of the companies, and Lawrence Lux, a director and CEO of the companies. Related entities include three companies and two entities that are consultants to the three companies. Beginning in December 2010, and continuing for another 18 months, two of the companies raised about $2.47 million from seven investors, at least $2 million of which was raised fraudulently. Mr. Daspin, the organizer of the scheme, targeted unemployed professional and solicited them for what was called a job interview. At the interview the executives were solicited to invest in the companies with a series of false statements. The companies never generated any revenue and quickly burned through the investor funds. The Order alleges violations of Exchange Act Sections 10(b) and 15(a) and Securities Act Sections 5(a), 5(c) and 17(a)(2) and (3). The action will be set for hearing.
Sale below minimum: In the Matter of State Trust Investments, Inc., Adm. Proc. File No. 3-16507 (April 23, 2015) is a proceeding which names the broker-dealer as a Respondent. The Order alleges that the firm sold non-investment grade bonds issued by the Commonwealth of Puerto Rico in violation of Municipal Securities Rulemaking Board Rule G-15(f) which sets a minimum denomination below which such bonds cannot be sold. Specifically, in March 2014 the firm made one sale of Puerto Rico bonds to a customer below the $100,000 minimum. The sale also violated MSRB Rule G-17 by not disclosing the minimum to the customer. To resolve the matter the firm consented to the entry of a cease and desist order based on the two MSRB Rules cited in the Order and to a censure. In addition, the firm will review the adequacy of its compliance procedures and pay a civil money penalty of $90,000.
Filings: In the Matter of W2007 Grace Acquisition I, Adm. Proc. File No. 3-16504 (April 22, 2015) is a proceeding which names the firm as a Respondent, a real estate investment entity that at one time was a reporting issuer. It went dark when the number of shareholders declined below 300, filing a Form 15 to suspend the requirement for filing periodic reports. Under Section 15(d) if the number of shareholders exceeds 300 on the first day of a fiscal year in the future, reports must be filed. Here the firm miscounted the number of shareholders as of January 1, 2014 by improperly treating certain distinct corporations and custodial accounts as single holders of record. The firm failed to begin making filings as required. The Order alleges violations of Exchange Act Section 15(d). To resolve the matter Respondent consented to the entry of a cease and desist order based on the Section cited in the Order, will resume filing periodic reports and agreed to pay a penalty of $640,000.
Required board reports: In the Matter of Kornitzer Capital Management, Inc., Adm. Proc. File No. 3-16503 (April 21, 2015) is a proceeding which names as Respondents the registered investment adviser and its CCO, Barry Koster. Kornitzer Capital managed certain funds which had a common board of trustees. Each year the board required a report analyzing the performance of the adviser. Mr. Koster prepared reports for the board beginning in 2010 and continuing through 2013. That report included expense allocation and represented that the adviser allocated employee compensation expenses based on estimated labor hours. In fact the estimates were manipulated to show consistent performance by the adviser. This violated Section 15(c) of the Investment Company Act. To resolve the matter each Respondent consented to the entry of a cease and desist order based on the Section cited in the Order. In addition, the adviser will pay a penalty of $50,000 while Mr. Koster will pay $25,000.
Conflicts: In the Matter of BlackBock Advisors, LLC, Adm. Proc. File No. 3-16501 (April 20, 2015). The Order names as Respondents BlackRock Advisers, a registered investment adviser, and Bartholomew Battista, the firm’s CCO. Daniel Rice III is a managing director and co-portfolio manager of energy sector assets held in BlackRock registered funds, private funds and separately managed accounts. His compensation derives in part from the management fees of the managed funds and separate accounts. In December 2006 Mr. Rice formed Rice Energy Irrevocable Trust to hold interests in Rice Energy, a name given to a then projected series of entities that would be formed. The next month Mr. Battista reviewed and discussed the matter with Mr. Rice. BlackRock concluded that the proposal did not present any conflict of interest. In February Mr. Rice formed the series of companies which were collectively known as Rice Energy. By March 2010 Rice Energy concluded a deal with ANR and formed a joint venture with Rice Energy. At the time of the deal funds and separate accounts managed by Mr. Rice held over two million shares of ANR stock. In January 2010 Mr. Rice told BlackRock that he wanted to serve on the board of directors of the joint venture. BlackRock’s Legal and Compliance Department reviewed the matter and concluded that there were potential conflicts of interest in entering into the joint venture in view of the portfolio holdings managed by Mr. Rice. The deal also raised concerns regarding access to ANR specific information that could be beneficial to Mr. Rice rather than his clients. Nevertheless, BlackRock permitted Mr. Rice to continue under certain restrictions. There was no follow-up by the firm. BlackRock did not inform the boards of directors of the Rice-managed registered funds or advisory clients about Rice Energy. No disclosure was made. Disclosure came in June 2012 when the Wall Street Journal published three articles about Mr. Rice and Rice Energy. The Order alleges violations of Advisers Act Sections 206(2), engaging in a course of conduct which constitutes a fraud and deceit, and Section 206(4)-7, failing to adopt and implement reasonable procedures to prevent the violation. In addition, Respondents caused certain BlackRock funds to violate Investment Company Act Rule 38(a)-1(a) which requires registered investment companies, through their chief compliance officer, to provide a report at least annually to the fund’s board of directors, addressing each material compliance matter that occurred since the date of the last report. To resolve the matter BlackRock agreed to a series of undertakings which include the retention of an independent compliance consultant who will prepare a report. The firm will adopt the recommendations. In addition, BlackRock consented to the entry of a cease and desist order based on the Sections cited in the Order. Mr. Battista also consented to the entry of a cease and desist order but based on Advisers Act Section 206(4) and a related rule and Investment Company Act Rule 38a-1. The firm agreed to pay a penalty of $12 million while Mr. Battista will pay $60,000. This is the first case to charge a violation of Investment Company Rule 38a-1.
Offering fraud: In the Matter of Russell C. Schalk, Jr., Adm. Proc. File No. 31555 (April 17, 2015); In the Matter of Joseph John Labadia, Adm. Proc. File No. 3-16499 (April 17, 2015). Mr. Schalk is currently a vice president of sales for Travel International. He is also the sole control person and a one third owner of Raintree Racing and the control person and CEO of a related entity, Raintree Farm. Mr. Labadia was an unregistered investment adviser who was a one third owner and member of the management committee of Raintree Racing. He is also a certified financial analyst and holds certain securities licenses. From 2007 through 2012 Messrs. Schalk and Labadia raised over $1.9 million from investors for Raintree racing. Investors were told that they were making short term principal protected investments in the venture which were characterized as loans. Investors were told that the current rate of return was 20% and that the venture was extremely low risk. Raintree Racing, however, lacked cash flow and did not have the financial ability to pay the promised 20% return. While investors were assured that their funds was a safe, over a three year period beginning in 2007, Mr. Schalk transferred about $668,000 from Raintree Racing to Raintree Farm. Some Raintree Racing investors were also offered the opportunity to invest in Raintree Farm. Investors did in fact purchase shares. The PPM, prepared by Mr. Schalk, failed to tell those investors that the Farm had a loss, minimal assets and was funded by Racing. From 2007 through 2011 Mr. Schalk also diverted about $220,000 from Raintree Racing and Raintree Farm accounts to his personal bank account. Mr. Labadia sold unregistered shares in a second venture, Atlanta Rehab, raising over $1.1 million. Atlanta Rehab investors were furnished with statements showing that the enterprise had an investment in Raintree Racing, valuing it at the offering price. At the time, a substantial portion of Atlanta Rehab funds were invested in Raintree Racing.
The Order in each proceeding alleges willful violations of Securities Act Sections 5(a), 5(c) and 17(a) and of Exchange Act Section 10(b). The Order as to Mr. Labadia alleges violations of Advisers Act Sections 206(1) and 206(2). Each Respondent settled, consenting to the entry of a cease and desist order based on the Sections cited in the Order in their respective action. Mr. Sahalk also agreed to pay disgorgement of $1,472,959, prejudgment interest and a third tier civil penalty of $1.6 million. An Administrative Law Judge will determine his ability to pay. Mr. Labadia is also barred from the securities business and from serving as an officer or director of a public company. He was ordered to pay disgorgement of $48,337 and prejudgment interest. Payment is suspended based on a sworn statement of an inability to pay.
Criminal cases
Investment fund fraud: U.S. v. Wessel (S.D.N.Y.) is an action in which Steven Wessel, who purported to be Chairman and Executive Managing Member of Steeplechase USA, LLC, an investment adviser, pleaded guilty to one count of securities fraud, one count of wire fraud and one count of aggravated identity theft. Mr. Wessel represented to an investor that his funds would be invested in securities. Subsequently, the investor was told that his $200,000 investment had appreciated substantially. In fact Mr. Wessel misappropriated it. When the investor demanded his funds back Mr. Wessel solicited a $550,000 from a second investor, claiming the funds would be used for financing a commercial real estate venture. In fact the funds were used to repay the firm investor with the balance being misappropriated. The date for sentencing has not been set.
Investment fund fraud: U.S. v. Kerye (E.D.N.Y.) is an action which named as defendants Diane Kaylor and Jason Kerye, former employees of Agape World, Inc. The two defendants played an instrumental role in seeking out the more than 3,800 investors who put about $370,000 in Agape World based on promises that their funds would be used for lending, were safe and that a high rate of return would be paid. In fact Agape World was largely a Ponzi scheme with few loans. When the fund collapsed there were about $147 million in investor losses. Nicholas Cosmo, the mastermind of the scheme, was previously sentenced to serve 25 years in prison. Following a four week jury trial the two defendants were found guilty of securities fraud, conspiracy, mail fraud and wire fraud. The date for sentencing has not been announced.
Manipulation: U.S. v. Bigelow (S.D.N.Y.) is an action against Dwayne Bigelow based on three pump-and-dump schemes. Specifically, Mr. Bigelow is alleged to have manipulated the shares of Emerging World Pharma, Inc., SMC Entertainment, Inc., and Sierra Resources Group, Inc., by having the firms engage in reverse mergers, retaining promoters to send e-mails touting the stock and then dumping his stock along with that of his coconspirators as the price rose. A superseding indictment contains one count of conspiracy, three counts of securities fraud and three counts of wire fraud. The case is pending.
Manipulation: U.S. v. Sarao, Case No. 1:15-cr-00075 (N.D. Ill. Filed Feb. 11, 2015). Defendant Navinder Singh Sarao is a futures trader from Hounslow, United Kingdom. A ten count criminal complaint charges him with wire fraud and commodities manipulation.
Mr. Sarao used an automated program to manipulate the market for E-Mini S&P 500 futures contracts on the Chicago Mercantile Exchange on May 6, 2010, contributing to the flash crash. The charging documents claim that Mr. Sarso employed a dynamic layering program in which he placed multiple orders simultaneously to sell at various price points to manipulate the market. The scheme created the appearance of market liquidity and substantial supply as well as an imbalance and pressure. When the market fell Mr. Sarao is alleged to have used futures contracts to repurchase at a lower price point. When it rose he took the opposite action. Another manipulative trading technique involved placing a large 2,000 lot sell order on one side of the market, executed another large order on the other side of the market and then cancelled the order. This created price movement which Mr. Sarao exploited, according to the criminal complaint. On May 6 five years ago as the price of the E-mini fell, the DJI followed. The Government is currently seeking extradition of Mr. Sarao from the U.K. to Chicago for trial.