This Week In Securities Litigation (Week ending June 9, 2017)
Chairman Clayton continued to build the senior staff this week, appointing Acting Enforcement Division Director Stephanie Avakian and Sullivan and Cromwell partner Steven Peikin as Co-Directors of the Division of Enforcement. The new Division co-directors identified cyber crime as the biggest threat to the markets in an interview with Bloomberg.
The Supreme Court handed the SEC a significant setback this week, rejecting its claim that the five year statute of limitations for the imposition of a penalty does not apply to claims for disgorgement. The Court’s opinion also raises questions regarding the Commission’s authority to seek disgorgement, one of its primary enforcement remedies.
The Commission filed three enforcement actions this week: one based on violating a prior bar order; a second for insider trading; and a third centered on AML violations.
Supreme Court
Statute of limitations: Kokesh v. SEC, No. 16-529 (decided June 5, 2017) construed Section 2462 of Title 28 which imposes a five year statute of limitations in “an action, suit or proceeding for the enforcement of any civil fine, penalty, or forfeiture . . .” The Court held that it applies to SEC requests for disgorgement. This is the second time the High Court has rejected SEC claims that the statute does not delimit its enforcement remedies. The first was in Gabelli v. SEC, 568 U.S. 442, 454 (2013) where the Court held that the statute applies to requests for civil penalties.
Justice Sotomayor, writing for the Court, stated that statutes of limitation are “vital to the welfare of society.” Section 2462 apples here if “SEC disgorgement qualifies as either a fine, penalty, or forfeiture.” A “penalty” under the statute is a form of punishment that is pecuniary and is imposed by the State for a crime or offence against its laws, according to the Court. To determine if disgorgement in SEC enforcement actions is a “penalty” the Court considered two points. First the Court considered whether the wrong being redressed is to the public or is private. SEC enforcement actions are brought to remedy a violation of law against the United States, not for an aggrieved individual, the Court found.
Second, the Court considered the purpose of the remedy – that is, if it is imposed for the purpose of punishment and to deter others. Courts which have addressed the question have repeatedly held that disgorgement is imposed in SEC enforcement actions to deter violations of the securities laws by depriving the person of any benefit from the wrongful conduct. This point is bolstered by the fact that awards of disgorgement are not compensatory. Accordingly, when, as here, “an individual is made to pay a noncompensatory sanction to the Government as a consequence of a legal violation the payment operates as a penalty,” the Court concluded.
Finally, the Court rejected the SEC’s claim that disgorgement is remedial and thus not subject to the statute of limitations. There are numerous instances where individuals have been ordered to disgorge more than their share of any illicit profits or without regard to the expenses incurred. Viewed in this context SEC disgorgement “bears all the hallmarks of a penalty” and is subject to the limitation period imposed by Section 2462.
SEC Enforcement – Litigated Actions
Manipulation: SEC v. Jammin’ Java Corp., Civil Action No. 2:15-cv-08921 (C.D. Cal. Ruling May 31, 2017) is an action in which the SEC prevailed on summary judgment. The complaint named as defendants the company, Shane Whittle, Wayne Weaver, Michael Sun, Rene Berlinger Stephen Wheatley, Kevin Miller, Mohammed Al-Barwani, Alexander Hunter and Thomas Hunter. The company was formed through a reverse merger with Global Electronic Recovery Corp., supposedly a waste management company. The shares were quoted on the OTC BB. Mr. Whittle served as CEO, Treasurer, Secretary and director of the company. Each of the other named defendants is a foreign national.
Beginning in 2010 Mr. Whittle, who arranged the reverse merger and held a controlling block of stock, exploited his position by coordinating an illegal offering and fraudulent promotion of the stock. Key was a financing arrangement publicized by the firm in 2010 under which Jammin Java supposedly obtained $2.5 million in financing from a company called Straight Path. In fact Straight Path did not exist. Prior to the deal announcement the share price for Jammin Java was $0.17 per share. Following the announcement the price climbed to $0.50 per share. Before the claimed financing, there was virtually no share trading. After the deal announcement trading volume increased from transactions by entities affiliated with Mr. Weaver. From late February to early April 2011 about 45 million shares were sold into the public markets by Mr. Weaver and the other defendants. These transactions yielded about $77.6 million in profits. The share price eventually collapsed from a high of $5.42 on May 12, 2011 to a low of $0.27 on December 30, 2011. The complaint alleged violations of Securities Act Sections 5(a) and 5(c) and Exchange Act Sections 10(b), 13(d), 16(a) and 17(b). The case is pending.
The SEC met its burden of proof, the Court found with respect to each of its three claims. First, with respect to its claim that Mr. Weaver sold unregistered securities in violation of Securities Act Section 5, there was no evidence that the shares were ever registered with the Commission. The evidence also established that Mr. Weaver, through his entities, sold the shares in the open market. Second, the Commission established that Mr. Weaver violated Exchange Act Section 13d, Mr. Weaver, through his companies, owned more than 5% of Jammin Java’s stock between March 8, 2011 and April 27, 2011. Yet no filing was made. Finally, the Court concluded that Mr. Weaver violated Exchange Act Section 10(b) based on his participation in the Straight Path financing arrangement. The scheme was clearly deceptive. When “Jammin Java announced that it had secured an investment of $2.5 million from a company called Straight Path, it neglected to mention that (1) Straight Path did not exist and had no money or bank account and (2) the financing would come from other companies, after those companies dumped Jammin Java stock on the public market. These facts would have been material to a reasonable investor” the Court found. Since the other elements of a claim were not contested, the Court found in favor of the SEC on this claim and granted summary judgment.
SEC Enforcement – Filed and Settled Actions
Statistics: Last week the SEC filed 2 civil injunctive cases and 1 administrative proceeding, excluding 12j and tag-along proceedings.
Violating bar order: In the Matter of Christopher David Scott: Adm. Proc. File No. 3-18016 (June 8, 2017) charges Mr. Scott, formerly the COO of a brokerage firm, with violating a consent order from a prior settlement with the Commission that barred him from associating with a broker-dealer. Despite that order, entered in 2013, Mr. Scott has been running the day to day operations of a broker-dealer under a consulting contract. This violates Exchange Act Section 15(b)(6)(B)(i) which makes it unlawful for any person against whom a bar order has been entered to willfully associate with a broker or dealer without the consent of the Commission, according to the Order. To resolve the matter Mr. Scott consented to the entry of a cease and desist order based on the Section cited in the Order. He is also barred from the securities business and from participating in any penny stock offering. In addition, Mr. Scott will pay disgorgement of $23,000, prejudgment interest and a civil penalty of $7,000.
Insider trading: SEC v. Trahan, Civil Action No. 17-cv-731 (W.D. LA. Filed June 6, 2017) is an action which names Michael Trahan, the owner of engineering consulting company Petra Consultants, Inc. It centers on the merger of Shaw Group, Inc. with Chicago Bridge & Iron Company N.V., announced on July 30, 2012. During the summer of 2012 Mr. Shaw was a consultant to Shaw. In that context he had an obligation of confidentiality to the firm. During his engagement, and before July 30, 2012, an employee of the firm told him about the merger. Mr. Trahan purchased 5,600 shares of Shaw common stock which he sold after the deal announcement for a profit of $69,735.00. The complaint alleges violations of Exchange Act Section 10(b). To resolve the case Mr. Trahan consented to the entry of a permanent injunction prohibiting future violations of Section 10(b). In addition, he agreed to pay disgorgement of $69,735.00, prejudgment interest and a penalty equal to his trading profits. See Lit. Rel. No. 23854 (June 7, 2017).
AML: SEC v. Alpine Securities Corporation (S.D.N.Y. Filed June 5, 2017). Alpine Securities is a Salt Lake based registered broker dealer. Much of its business involves clearing microcap stock transactions for other firms. The broker has a history of disciplinary actions with FINRA. In 2011 Alpine was acquired by John Hurry, the owner of Scottsdale Capital Advisors Corporation, an Arizona based broker dealer that introduces clients to Alpine. Alpine is subject to the Bank Secrecy Act. The Act requires broker-dealers to file suspicious activity reports or SARs with FinCEN for certain suspicious transactions. Alpine implemented the BSA and FinCEN requirements by maintaining written supervisory procedures which identified red flags when a SAR should be filed and required that the facts regarding the matter be identified in the form. Since 2011 much of the firm’s business has come from Scottsdale. That firm was disciplined by FINRA in 2011 for filing deficient SARs. Many of the firm’s customers have also been charged with violations of the securities laws. Those include transactions that have been cleared by Alpine. Alpine permitted the transactions but charged higher fees. Despite the dictates of its compliance system, Alpine had a standard procedure which called for the use of two templates for SARs, neither of which required that key facts about the activity be specified. Beginning in May 2012 FINRA conducted an examination of Alpine. After reviewing 823 SARs the regulator concluded that all were substantively inadequate. None furnished a description of the reason the activity was suspicious. Alpine took no meaningful steps to remedy the deficiencies. Three years later, in April 2015, the Commission’s Office of Compliance Inspections and Examinations conducted an examination. The deficiencies identified by FINRA continued. A deficiency letter was issued. Alpine’s conduct continued unabated. Over the period the broker filed almost 2,000 SARs that failed to identify the material facts regarding the suspicious activity. The firm also failed to identify when stock deposited was liquidated in 1,900 transactions as required and repeatedly filed forms late. These repeated failures were directly contrary to the firm’s compliance system requirements. The Commission’s complaint alleges violations of Exchange Act Section 17(a). The case is in litigation.
FINRA
Private securities transactions: A hearing panel barred registered representative Jim Seol from participating in private securities transactions, engaging in undisclosed outside business activities and making misrepresentations to his employer. The order stems from Mr. Seol’s activities, through his firm, Western Regional Center Inc. Specifically, the panel concluded that Mr. Seol sold $100 million of limited partnership interest securities tied to EB-5 immigration programs to foreign nationals in Korea and China seeking a path to citizenship in the U.S. In return for his efforts Mr. Seol was paid management fees of $736,000 per year. Mr. Seol failed to disclose these activities to his employer, concealed them and claimed at the hearing he did not know the interests were securities – testimony the panel found to lack credibility.