This Week In Securities Litigation (Week ending September 25, 2015)

The Commission responded to critics of its administrative proceedings this week, proposing changes to the Rules of Practice which govern them. If adopted the new rules would modify the time period within which the actions must be completed, permit depositions and provide for electronic filing.

SEC Enforcement prevailed in an insider trading action filed in 2010 when a jury returned a verdict in favor of the agency and against both defendants. The Commission also filed its first action centered on cybersecurity this week along with a financial fraud case against retailer Stein Mart. Actions were also brought that are centered on market manipulation, insider trading and offering fraud claims.

SEC

Proposed rules: The SEC proposed to amend the Rules of Practice for administrative proceedings. Under the proposals, the timing for the hearing will be adjusted, parties will be permitted to take depositions and there will be electronic filing (here).

Data base: Chair Mary Jo White announced a “New Rulemaking Database” that is available to the public (here).

Proposed rules: The SEC proposed liquidity management rules for mutual funds and ETFs (here).

SEC Enforcement – Litigated Actions

Insider trading: SEC v. Berrettini, Civil Action No. 10-CV-01614 (N.D. Ill. Mar. 31, 2010) is an action against Ralph Pirtle, former Director of Real Estate for Philips Electronics North America, a subsidiary of Royal Philips, N.M. and his friend Morando Berrettini. Mr. Pirtle illegally tipped his friend about the interest of Philips in acquiring Lifeline Systems, Inc., Invacare Inc. and Intermagnetics Corporation, according to the complaint. In each instance, Mr. Berrettini traded, making a total profit of over $240,000. In a series of side dealings, Mr. Berrettini used cashiers checks to purchase goods and services for Mr. Pirtle. The complaint alleged violations of the Exchange Act antifraud provisions. On September 24, 2015 a jury in Chicago returned a verdict in favor of the agency and against each defendant on Counts 1-3. Counts 4-6 were plead in the alternative and thus were not considered.

SEC Enforcement – Filed and Settled Actions

Statistics: During this period the SEC filed 5 civil injunctive cases and 6 administrative actions, excluding 12j and tag-along proceedings.

Manipulation: In the Matter of G Asset Management, Adm. Proc. File No. 3-16831 (Sept. 24, 2015) is a proceeding which names as Respondents the unregistered investment adviser, and Michael Glickstein, its president and CIO. G Asset advises three funds. On February 21, 2014 the adviser announced that it had offered to purchase a majority interest in Barnes & Noble, Inc., for $22 per share. In fact it had no ability to implement the transaction. Nevertheless, the adviser caused the funds it advised to purchase Barnes & Noble shares. The activity resulted in a NYSE five minute trading halt. Once trading resumed the adviser had the funds sell portions of the shares. After the market closed the investment funds exercised thousands of in-the-money call options resulting in the purchase of 184,000 shares. Most of those were sold at a profit on Monday, February 24, 2014. Overall the funds had profits of about $168,000 as a result of the press release. The Order alleges violations of Securities Act Section 17(a) and Exchange Act Section 10(b). Each Respondent resolved the case, consenting to the entry of a cease and desist order based on the Sections cited in the Order. The firm was censured and Mr. Glickstein was barred from the securities business with a right to request reinstatement after five years. In addition, Respondents will, on a joint and several basis, pay disgorgement of $168,000 along with prejudgment interest. Mr. Glickstein will pay a penalty of $100,000.

Manipulation: SEC v. Gaianis, Civil Action No. 1:15-cv-07546 (S.D.N.Y. Filed Sept. 24, 2015) is an action which names as defendants Jason Galanis, a securities law recidivist; John Galanis, the father of defendants Jason, Jared and Derek Galanis; Gary Hirst and Gavin Hamels, a portfolio manager and investment adviser representative. John Galanis was previously convicted in a federal criminal action; Jared is an attorney; Derek previously pleaded guilty in another federal criminal action; and Gary Hirst served as president of Gerova Financial Group, Ltd. In early 2010 the defendants engaged in a scheme under which 11 million unregistered shares of Genova were transferred to a family friend from the Republic of Kosovo. Once the shares were put in the friend’s name they were deposited in three brokerage accounts in the U.S. Orders were then placed to sell the shares. To sustain the price manipulative trading was used. Two investment advisers were bribed to buy Gerova shares. Overall the scheme resulted in over $16 million in profits. The complaint alleges violations of Securities Act Sections 5(a), 5(c), 17(a)(1), Exchange Act Sections 9(a)(1), 10(b) and 20(e) and Advisers Act Sections 206(1) and (2). The case is pending. See Lit. Rel. No. 23360 (Sept. 24, 2015). The Manhattan U.S. Attorney’s Office filed a parallel criminal action.

Insider trading: SEC v. Condon, Civil Action No. 2:15-cv-07443 (C.D. Cal. Filed Sept. 23, 2015) is an action which names as defendants Richard Condon and Jonathan Ross. Mr. Condon is a “life coach.” Mr. Ross is a close friend of Mr. Condon. This action centers on the bidding by Panda Restaurant Group to acquire PF Chang’s China Bistro, Inc. Mr. Condon worked as an executive coaching consultant for Panda. During the course of his work in late 2011 and early 2012 he learned that Panda was interested in Chang’s. Initially, the deal fell through. Later it was resurrected. In both instances Mr. Condon learned about the proposals and tipped his friends Mr. Ross and Howard Schultz. When the deal was resurrected Messrs. Ross and Schultz bought risky short term options. Once the deal was announced on May 1, 2012 the value of the options increased and the two men sold them. Mr. Ross realized about $58,281 while Mr. Schultz had about $231,447 in illicit trading profits. Mr. Ross also shared the information with Ali Sagheb who had trading profits of $17,994. After the deal Messrs. Condon and Ross took steps to conceal their activities. Mr. Condon, for example, lied to Panda when asked if he could identify “Schultz, H.” The complaint alleges violations of Exchange Act Sections 10(b) and 14(e). The case is pending. See Lit. Rel. No. 23359 (Sept. 24, 2015).

Investment fund fraud: In the Matter of William B. Fretz, Adm. Proc. File No. 3-16829 (Sept. 23, 2015) is an action which names as Respondents, Mr. Fretz, John Freeman, Covenant Partners, L.P. and Covenant Capital Management Partners, L.P., an unregistered investment adviser. Both Mr. Fretz and Mr. Freeman were partners in Covenant Capital. Beginning in 1999 Messrs. Fretz and Freeman raised about $7.3 million through the sale of Covenant partnership interests to 58 limited partners. Those investors were told the funds would be used primarily to invest in direct marketing companies and that fees would only be paid to the adviser under certain circumstances. After some initial investments consistent with those representations, the two men diverted much of the investor money to their own use. The Order alleges violations of Securities Act Sections 17(a), Exchange Act Section 10(b) and Advisers Act Sections 206(1), 206(2) and 206(4). To resolve the action each Respondent consented to the entry of a cease and desist order based on the Sections cited in the Order except Covenant whose order is based only on Securities Act Section 17(a) and Exchange Act Section 10(b). Messrs. Fretz and Freeman were also barred from the securities business and from participating in any penny stock offering. In addition Respondents, jointly and severally, will pay disgorgement of $5,476,928 along with prejudgment interest. Each individual Respondent will also pay a civil penalty of $500,000. The monetary payments are being made to the bankruptcy trustee for Covenant Partners.

Financial fraud: In the Matter of Stein Mart, Inc., Adm. Proc. File No. 3-16826 (Sept. 22, 2015). Stein Mart is a national retailer that operates 270 retail apparel stores in 30 states. The company frequently marks down the price of its merchandise. Typically it uses three classifications: 1) temporary or point of sale markdowns; 2) permanent markdowns; and 3) permanent point of sale or Perm POS markdowns. Stein Mart accounted for the reduced value of inventory subject to a temporary mark down at the time of sale. In contrast, for inventory that was permanently marked down the firm reduced the value at the time of the mark down. For Perm POS markdowns Stein Mart used the same valuation approach as for temporary mark downs which is contrary to GAAP. Until 2011 the firm did not have adequate internal controls concerning Perm POS markdowns to discover the significance impact they had on results. In 2012 the chair of the audit committee determined that the firm was not correctly accounting for Perm POS markdowns. The external auditors concluded that the current practice was an error. The firm subsequently restated its financial results for the first quarter of 2012, each quarter of 2011 and for the annual results for 2010. The restatement resulted in quarterly changes in pre-tax income which were material in many instances. In the process other deficiencies in controls were discovered. The Order alleges violations of Exchange Act Section 13(a), 13(b)(2)(A) and 13(b)(2)(B). To resolve the matter, the firm consented to the entry of a cease and desist order based on the Sections cited in the Order. In addition, Stein Mart agreed to pay a penalty of $800,000. The Commission considered the firm’s remedial actions and cooperation in deciding to accept the offer of settlement.

Market crisis: SEC v. Mudd, Civil Action No. 11-cv-9202 (S.D.N.Y.) is a previously filed action against several former senior officers of Fannie Mae. This week the Court approved a settlement with defendants Enrico Dallavecchia, the former chief risk officer of the firm, and Thomas A. Lund, a former senior vice president. The stipulation and order approved by the Court calls for each defendant to refrain from signing certain periodic reports for twelve months, prohibits them from executing SOX certifications and from violating the antifraud and reporting provisions of the federal securities laws. Mr. Dallavecchia will pay $25,000 to the U.S. Treasury while Mr. Lund will pay $10,000. See Lit. Rel. No. 23358 (Sept. 22, 2015).

Financial reporting: In the Matter of Idle Media, Inc., Adm. Proc. File No. 3-16828 (Sept. 22, 2015) is a proceeding which names as Respondents the company, a developer and operator of websites focused on music, and Marcus Frasier, its founder and CEO. From August 2012 through December 30, 2013 when it was a reporting company, the firm failed to properly file the required periodic reports. Specifically, the firm failed to consolidate a subsidiary, causing a restatement and, when it did the consolidation, it was done improperly causing a second restatement. While Mr. Frasier was supposed to keep the books and records he failed to do so, causing the violations. The Order alleges violations of Exchange Act Sections 12(g), 13(a), 13(b)(2)(A) and 13(b)(2)(B). Each Respondent consented to the entry of a cease and desist order based on the Sections cited in the Order. In addition, each Respondent will pay a $50,000 penalty.

Cybersecurity: In the Matter of R.T. Jones Capital Equities Management, Inc., File No. 3-16827 (Sept. 22, 2015). R.T. Jones is a registered investment adviser based in St. Louis, Missouri. The firm provides investment advice to retirement plan participants under various agreements with plan administrators and sponsors using model portfolios. Plan participants essentially enroll through the firm website where they furnish personal information and fill out a questionnaire which is the basis for R.T. Jones recommendations. The firm maintains information on all 100,000 plan participants. The information was stored on a third party-hosted server. It was not encrypted. In July 2013 the firm discovered a potential cybersecurity breach at the server. A consultant confirmed that the attack was launched from multiple IP addresses based in China. There is no indication to date that clients suffered any financial harm from the attack. The SEC’s Safeguard Rule, adopted in 2000, requires that every investment adviser adopt policies and procedures with certain protections. R.T. Jones failed to adopt any written policies and procedures in accord with the Rule. The Order alleges violations of Rule 30(a), Regulation S-P. To resolve the proceeding Respondent consented to the entry of a cease and desist order based on the Rule cited in the Order and to a censure. R.T. Jones will also pay a penalty of $75,000. The Commission considered the firm’s remedial actions and cooperation in resolving the action.

Fraudulent scheme: SEC v. Morelli, Civil Action No. 15-cv-13396 (D. Mass. Filed Sept. 21, 2015) is an action which names as defendants Frank Morelli III and Louis Buonocare. The two men secretly controlled YaFarm Technologies Inc., a company which claimed to provide stem cell therapy. The two put out false press releases including one claiming an agreement with Integrative Stem Cell Institute. The share price and trading volume increased as the two defendants sold shares for over $1.2 million. The complaint alleges violations of Securities Act Sections 5(a), 5(c) and 17(a) and Exchange Act Section 10(b). The action is pending. The U.S. Attorney’s Office for Massachusetts filed a parallel criminal action. See Lit. Rel. No. 23355 (Sept. 21, 2015).

Financial fraud: SEC v. Apuzzo, Civil Action No. 3:07-cv-1910 (D. Ct.) is a previously filed action against Joseph Apuzzo, the former CFO of Terex Corporation. The complaint alleged that Mr. Apuzzo participated in two fraudulent sale-lease-back transactions involving his former firm. This week the Court entered a final judgment against Mr. Apuzzo, enjoining future violations of Exchange Act Sections 10(b), 13(a), 13(b)(2)(A) and 13(b)(5). He was also ordered to pay a penalty of $100,000. Upon motion of the SEC the Court will determine if an officer-director bar should be entered. Mr. Apuzzo also agreed to the entry of a Commission order suspending him from appearing or practicing before the Commission as an accountant with a right to apply for reinstatement after five years. See Lit. Rel. No. 23356 (Sept. 21, 2015).

Fees: In the Matter of First Eagle Investment Management, LLC, Adm. Proc. File No. 3-16823 (Sept. 21, 2015). Respondent First Eagle Investment Management is a registered investment adviser. FEF Distributions, LLC, also a Respondent, is a registered broker-dealer which is a wholly owned subsidiary of First Eagle. The firm serves as the principal underwriter and distributor for its parent. FEF entered into agreements with two financial intermediaries for select distribution and shareholder services. One agreement was for what are called sub-TA service, such as maintaining separate records for each customer in an omnibus account for each fund, transmitting purchase and redemption orders and similar services. Sub-TA services are traditionally paid from fund assets. The other two were for services related to the distribution of fund shares which must be paid out of a Rule 12(b)-1 plan. In fact all the fees were paid from fund assets, contrary to what was told to the board and the disclosure. The Order alleges violations of Advisers Act Section 206(2) and Investment Company Act Section 12(b). To resolve the case, Respondent FEF will implement a series of undertakings which include the retention of an independent compliance consultant. The firms also undertook remedial efforts and cooperated with the staff investigation which was acknowledged. First Eagle consented to the entry of a cease and desist order based on Advisers Act Section 206(2) and Section 12(b) of the Investment Company Act along with a censure. The firm will also pay disgorgement of $24,907,354 along with prejudgment interest. FEF consented to the entry of a cease and desist order based on Investment Company Act Section 12(b). Respondents will pay, on a joint and several basis, a penalty of $12.5 million. Within 10 days Respondents will deposit $39,747,879.75 into a distribution fund which will reimburse shareholders.

Offering fraud: SEC v. Milligan, Civil Action No. 2:15-cv-07308 (C.D. Cal. Filed Sept. 17, 2015) is an action which names as a defendant Robert DeWayne Milligan. The complaint alleges that beginning in May 2010, and continuing over the next four years, the defendant raised about $1.3 million selling the unregistered shares of America’s Natural Energy to thirty nine investors. Mr. Milligan claimed the firm was in the oil and gas exploration business in the Williston Basin of North and South Dakota. In fact the defendant misappropriated the funds. The complaint alleges violations of Securities Act Sections 5(a), 5(c) and 17(a) and Exchange Act Sections 10(b) and 20(a). The action is pending. See Lit. Rel. No. 23354 (Sept. 18, 2015).

False press releases: SEC v. Ivakhnik, Civil Action No. 15-cv-7263 (S.D.N.Y. Filed Sept. 17, 2015) is an action against George Ivakhnik and his firm, The Mobile Star Corporation. Shortly after becoming CEO of the company in the spring of 2012 Mr. Ivakhnik began issuing a series of false press releases regarding the company. Those releases falsely claimed the company had considerable financial resources and was engaged in several lines of business. The releases had no real factual basis. The Commission suspended trading in the stock. The complaint alleges violations of Securities Act Section 17(a) and Exchange Act Sections 10(b) and 20(a). See Lit. Rel. No. 23353 (Sept. 17, 2015).

Mircocap fraud: In the Matter of John Briner, Esq., Adm. Proc. File No. 3-16339 (Jan. 15, 2015). The Order named as Respondents two attorneys, two audit firms and seven auditors. The action is an out-growth of stop order proceeding brought in January by the Commission based on a series of sham offerings for mining companies. The scheme was orchestrated by suspended attorney, John Briner, who recruited figureheads as the heads of the entities. Each of the offerings was alleged to be a sham. The audit firms and their auditors claimed to have audited the financial statements of the firms when in fact they did not. The Order alleges violations of Securities Act Section 17(a) by the attorneys and unprofessional conduct by the audit firms and auditors. While the proceeding was initially set for hearing, now the charges have been resolved as to each Respondent except Ms. Balmy, an attorney: John Briner: consented to the entry of a cease and desist order based on Securities Act Section 17(a). He is also barred from participating in any penny stock offering and is suspended from appearing and practicing before the Commission as an attorney. In addition, he will pay $20,000 in disgorgement, prejudgment interest and a penalty of $50,000. De Joya Griffith, LLC: consented to the entry of a cease and desist order based on each subsection of Securities Act Section 17(a). The firm is denied the privilege of appearing or practicing before the Commission as an accountant with the right to apply for reinstatement after five years. The firm will pay disgorgement of $37,500, prejudgment interest and a penalty of $18,750. M&K CPAS PLLC: consented to the entry of a cease and desist order based on Securities Act Sections 17(a)(2) and (3). The firm was also censured and agreed to certain undertakings which include not accepting new clients for a period of twelve months and retaining an independent consultant. The firm will pay disgorgement of $49,500, prejudgment interest and a penalty of $50,000. Arthur De Joya, CPA:consented to the entry of a cease and desist order based on each subsection of Securities Act Section 17(a). Mr. De Joya is denied the privilege of appearing or practicing before the Commission as an accountant with the right to apply for reinstatement after three years. He will also pay a penalty of $15,000. Jason Griffith, CPA: consented to the entry of a cease and desist order based on each subsection of Securities Act Section 17(a). He is denied the privilege of appearing or practicing before the Commission as an accountant with the right to apply for reinstatement after three years will also pay a penalty of $15,000. Philip Zhang, CPA: consented to the entry of a cease and desist order based on each subsection of Securities Act Section 17(a). He is also denied the privilege of appearing or practicing before the Commission as an accountant with a right to apply for reinstatement after five years. In addition, Mr. Zhang will pay a civil penalty of $25,000. Matt Manis, CPA: consented to the entry of a cease and desist order based on Securities Act Sections 17(a)(2) and (3). He is also denied the privilege of appearing or practicing before the Commission as an accountant and will pay a penalty of $20,000. Jon Ridenour, CPA:consented to the entry of a cease and desist order based on Securities Act Sections 17(a)(2) and (3). He is also denied the privilege of appearing or practicing before the Commission as an accountant and will pay a penalty of $15,000. Ben Ortego, CPA: consented to the entry of a cease and desist order based on Securities Act Sections 17(a)(2) and (3). Mr. Ortego is also denied the privilege of appearing or practicing before the Commission with the right to apply for reinstatement after three years. He will also pay a penalty of $50,000. Chris Whetman, CPA: was dismissed from this action but settled with the Commission in a related proceeding. In the Matter of Christopher D. Whetman, CPA, Adm. Proc. File No. 3-16821 (Sept. 18, 2015). To resolve this proceeding, based on his audits of Idle Media, Inc., he consented to the entry of a cease and desist order based on Securities Act Sections 17(a)(2) and (3). Mr. Whetman is also denied the privilege of appearing or practicing before the Commission with the right to apply for reinstatement after five years. He will pay a penalty of $15,000.

PCAOB

Agreement: The Board entered into a cooperative arrangement with the Commission de Secteur Financier of Luxembourg. It relates to oversight of audit firms subject to the regulatory jurisdiction of each regulator.

Criminal Cases

Remarks: Assistant AG Leslie R. Caldwell addressed the Second Annual Global Investigations Review Conference, New York, New York (Sept. 22, 2015). In her remarks Ms. Caldwell reviewed recent FCPA actions and discussed the Yates Memo, noting that a firm could obtain cooperation credit even if it failed to identify the individuals responsible if the investigation was complete (here).

Confidential information: U.S. v. Marsh (S.D.N.Y.) is an action against Galen Marsh, formerly an employee in the private wealth management division of a bank. He used his position over a period of three years beginning in 2011 to upload the personal and financial information of about 730,000 clients to his home computer for his personal advantage. Beginning in late 2013 he was in discussions with competitors. He pleaded guilty this week to obtaining confidential client information.

Bitcoin: U.S. v. Shavers (S.D.N.Y.) is an action in which Trendon Shavers pleaded guilty to one count of securities fraud in connection with a Ponzi scheme he operated based on bitcoin and tied to Bitcoin Savings and Trust. Mr. Shavers operated BS&T, promising those who deposited bitcoin in the on-line bank that the funds would be used in arbitrage transactions, that they would be paid 7% interest per week (or 3,641% per year) and that they were guaranteed against lost. In fact the institution, which he operated for about one year beginning in late 2011, was a Ponzi scheme. In a parallel civil action brought against Mr. Shavers the court entered a judgment directing that he pay over $40 million in disgorgement and prejudgment interest and a civil penalty of $150,000.