This Week In Securities Litigation (Week ending March 15, 2019)
The Musk – SEC saga continued. This week Mr. Musk filed a response to the SEC’s papers seeking a contempt citation, not only arguing his position but blasting the agency. While the debate over the merits of the court proceedings continues, unfortunately the shareholders and investors seem to be getting lost. The point is this: Mr. Musk made a deal to install certain corporate governance procedures as set forth in the Court’s order. While it is clear he did not “pre-clear” the specific tweet under the order as he admits, the content of his statement had already been published by the company. That should be sufficient. It is time to end these proceedings.
The SEC’s signature achievement this week is the Share Class Disclosure Selection Initiative. Under this program the agency filed 79 settled actions for firms that self-reported, admitted to not disclosing the conflict that comes from accepting undisclosed fees in connection with acquiring mutual fund shares for clients. Overall those settling with the Commission will pay $125 million.
Finally, the SEC filed a series of cases focused largely on the microcap markets. Three centered on offering frauds, one was brought against a recidivist attorney who sought to circumvent being essentially barred from writing false legal opinions to permit the sale of unregistered shares and another penalized a brokerage firm for failing to have adequate supervision procedures regarding manipulative conduct involving penny stocks to halt those actions by a registered representative. One action brought last week was not tied to the microcap markets. Rather, it charged a retail firm with making false statements regarding its products.
SEC
Remarks: Chairman Jay Clayton delivered remarks titled Equity Market Structure, Looking Back & Moving Forward, New York, New York (March 8, 2018). His remarks focused on the initiative competed last year, thinly-traded securities, combating retail fraud and 4) market access and data. The remarks are a dialogue with Brett Redfearn, Director, Division of Trading and Markets (here).
SEC Enforcement – Filed and Settled Actions
The Commission filed 3 civil injunctive actions and 3 administrative proceedings this week, exclusive of 12j and tag-along actions. In addition, 79 settled administrative proceedings were filed under the SCDSI.
False legal opinions: SEC v. Dalmy, Civil Action No. 1:19-cv-00745 (D. Colo. Filed March 13, 2019) is an action which names attorney Diane Dalmy as a defendant. In September 2009 OTC Markets Group Inc., the largest U.S. electronic quotation and trading system for OTC stocks placed Ms. Dalmy on the list of prohibited attorneys. To evade this action Ms. Dalmy recruited a retired divorce attorney who executed legal opinions she authored claiming microcap stocks were free trading. The opinions were false. Ms. Dalmy has previously been barred from practicing before the Commission and is currently in prison. The complaint alleges violations of Securities Act Section 17(a), Exchange Act Section 10(b) and the Commission’s bar order. The case is in litigation. See Lit. Rel. No. 24421 (March 13, 2019)
Offering fraud: SEC v. Gallagher, Civil Action No. 19-cv-0575 (N.D. Tx. Unsealed March 12, 2019) is an action which names as defendants William “Doc” Gallagher, a radio personality and two firms he controls, Gallagher Financial Group, Inc. and W. Neil Gallagher, PhD. Agency, Inc. “Doc” Gallagher – the so-called “Money Doctor”- marketed a product he called the Diversified Growth and Income Strategy Account. It promised returns of 5% to 8% per year with no losses guaranteed — it would generate retirement income. The radio show was spiked with religious references to attract older religious investors. A group of 60 investors, ranging in age from 62 to 91, invested over $19.6 million dollars with Defendants. Little of the money was actually invested. The scheme is presently continuing. The complaint alleges violations of each subdivision of Securities Act Section 17(a), Exchange Act Section 10(b), and Advisers Act Sections 206(1) and (2). The case is pending. See Lit. Rel. No. 24420 (March 12, 2019).
Offering fraud: SEC v. River North Equity LLC, Civil Action No. 1:19-cv-01711 (N.D. Ill. Filed March 11, 2019) is an action which names as defendants: River North, an investment firm that deals in penny stocks; Edward Liceaga, the firm’s President and manager; Michael Chaves, a former employee of North River barred by FINRA; NanoTech Entertainment, Inc., the producer of technology such as video streaming platforms; NanoTech Gaming, Inc., the producer of a skill-based pinball game; David Foley, the founder of NanoTech and its CEO and COO; Lisa Foley, the wife of David Foley; Jeffrey Foley, the brother of David; and Bennie Blankenship, a stock promoter. Defendant David Foley orchestrated the distribution and manipulation of shares between 2014 and 2016. Specifically, he sold 1.1 billion shares of NanoTech Entertainment stock and 19.1 million shares of NanToech Gaming stock to River North Equity in a series of unregistered transactions. Later the shares were sold to the public. David Foley also prepared the financial statements for the two firms which were published on the website of OTC Markets Group, Inc. Those financial statements were materially false. The scheme continued under the direction of David Foley even after he pleaded guilty in two unrelated criminal cases and was put in prison. The complaint alleges violations of each subsection of Securities Act Section 17(a) and Exchange Act Sections 9(a), 10(b) and 15(a). The case is pending. See Lit. Rel. No. 24419 (March 12, 2019).
Offering fraud: In the Matter of Kiarash (KLA) Jam, Adm. Proc. File No 3-19103 (March 12, 2019) is a proceeding which names as a Respondent an independent producer and financier of motion pictures. Over a two year period, beginning in later 2012, Respondent and David Bergstein, engaged in two unregistered securities offerings. The first involved the shares of Glendon Group, Inc., a shell company and Bidz.com Inc., an on-line jeweler that supposedly was being taken private. In the offering, which raised about $5.6 million from 11 investors, Respondent made misrepresentations about the funds Glendon had raised, the number of securities of Glendon available for purchase and the timing of the transaction. Respondent also misappropriated a portion of the offering proceeds. In the second Respondent and Mr. Bergstein raised about $580,000 for Glendon by selling Units of the firm’s securities owned by Mr. Bergstein for the claimed purpose of spinning off Modnique.com, a separate business unit of Bidz, to take it public through an IPO. In this transaction Respondent lied to investors about key parts of the transaction and misappropriated a portion of the offering proceeds. The Order alleges violations of Securities Act Section 17(a) and Exchange Act Sections 10(b) and 15(a). To resolve the proceedings Respondent consented to the entry of a cease and desist order based on the sections cited in the Order and agreed to be barred from the securities business and from participating in any penny stock offering. He also agreed to pay disgorgement of $205,443.00, prejudgment interest of $86,278.75 and a penalty of $185,000.
Failure to supervise: In the Matter of Wedbush Securities, Inc., Adm. Proc. File No. 3-18411 (March 12, 2019) is a proceeding naming the registered representative as a Respondent. The action centers on a failure to supervise. Specifically, in late 2012 and 2013 the firm failed to follow-up on a series of red flags regarding the manipulative trading being conducted in penny stocks by registered representative Timary Delorme. Those red flags included: 1) email outlining her role in fraudulent transactions; 2) receiving copies of two FINRA arbitrations filed by customers that contained allegations about her role in their investments in the same penny stocks; 3) learning of a FINRA inquiry into her personal trading; and 4) learning about another FINRA inquiry into allegations underlying the customer arbitrations. The Order alleges violations of Securities Act Sections 17(a)(1) and (3) and Exchange Act Sections 9(a)(2) and 10(b). In resolving the matter the Commission took into consideration the firm’s remedial acts which included naming two new co-presidents and improvements to the supervision system, updating its policies and procedures regarding internal investigations, allocating additional resources to internal audit and internal control groups and adding an independent chair of the audit committee. In resolving the proceedings Respondent consented to a censure under Exchange Act Section 15(b)(4)(E) and agreed to pay a penalty of $250,000.
False statements: In the Matter of Lumber Liquidators Holdings, Inc., Adm. Proc. File No. 3-10104 (March 12, 2019) is a proceeding which names the seller of hardwood flooring as Respondent. In July 2014 a news program aired claiming that the firm was selling flooring that contained levels of formaldehyde exceeding standards set by California Air Resources Board or CARB. Lumber Liquidators responded in a series of public statements claiming that its products were all certified by CARB, that it had documented proof of compliance and that products were rigorously tested. In fact, the firm knew by December 15, 2014 that products manufactured at a Chinese supplier exceed the CARB standards and that the video aired was of workers at that plant – its claims were false. The Commission considered the remedial acts of the firm and did not impose a penalty in view of the criminal penalty impose of $19,095,648 by the U.S. Attorney’s Office for the Eastern District of Virginia. To resolve the proceedings the firm consented to the entry of a cease and desist order based on Exchange Act Sections 10(b) and 13(a). Respondent will also pay disgorgement of $6,037,738 and prejudgment interest of $59,660.
SCSDI Initiative: The initiative offered firms that failed to disclose the payment of 12b-1 fees tied to the purchase of mutual fund shares standardized settlement terms and no penalty for self-reporting, agreeing to repay investors and correcting their disclosures. Under the program 79 advisors self-reported and agreed to pay a total of $125 million.
Criminal cases
Theft: U.S. v. Middendorf, No. 1:18-cr-00036 (S.D.N.Y.). Former KPMG partner David Middendorf and former PCAOB official Jeffrey Wada were each found guilty of conspiring to steal secret Board inspection schedules for KPMG to give the firm an edge in the process. Each was found guilty of conspiracy to commit wire fraud and wire fraud but acquitted of conspiracy to defraud the government. Previously, co-defendants Thomas Whittle and Brian Sweet entered into plea deals which in part required them to testify for the government. Defendant Britt was severed from the case and is awaiting trial. The defendants are awaiting sentencing. See also In the Matter of Brian Sweet, CPA, Adm. Proc. File No. 3-18347 (Jan. 22, 2018); In the Matter of Cynthia Holder, CPA, Adm. Proc. File No. 3-18346 (Jan. 22, 2018).
Pyramid scheme: U.S. v. Ignatov (S.D.N.Y. March 8, 2019) is an action which names as defendants the brother and sister team of Konstantin and Ruja Ignatov, both of Sofia, Bulgaria. Ms. Ignatov is the founder of OneCoin Ltd. which purports to issue a crypto coin but which is actually a multilevel pyramid scheme – the coin is a fraud. Founded in 2014 in Sofia, Bulgaria, OneCoin Ltd. operated as a multi-level marketing network. Members could receive commissions for recruiting others to purchase cryptocurrency packages. The firm claims to have over 3 million members around the world. The coins were marketed with a series of misrepresentations which include false claims asserting that the coins were “mined,” that they are increasing in value and that they are linked to a blockchain. Each claim is false. Nevertheless, the company has been sent millions of dollars from investors around the world. Mark Scott agreed to launder the proceeds of the scheme. Konstantin Ignotov is charged with one count of conspiracy to commit wire fraud; Ruju is charged with one count each of wire fraud, conspiracy to commit wire fraud, securities fraud and conspiracy; and Mark Scott is charged with one count of conspiracy to commit money laundering. The case is pending.