Trends in SEC Enforcement: 1Q23, Part II
This is the second part of a series focused on the cases filed by the SEC during the first quarter of 2023. The first segment was published on Tuesday, August 22, 2023. It analyzed the basic statistics for the quarter – 80 new enforcement actions were filed (here). The four largest groups of actions initiated during the period were offering frauds, crypto assets, manipulation and insider trading. Two examples of the cases filed in each group are detailed below.
Offering fraud
This is traditionally, one of the largest groups of cases filed each year. The variety of these cases is virtually limitless. Below are two examples of the offering fraud actions filed in the first quarter of this year. The first centers on claims that those soliciting the investment have a “unique” blockchain which will provide outsized returns, a favorite sales pitch in these cases. One of those involved in the case is a convicted felon. In the second those soliciting investments claimed to have an “algorithm that could identify stocks poised for growth.” This, and variations of it, is a sales pitch seen in many of these types of cases.
SEC v. Chandran, Civil Acton No. 2:33-cv-10017 (E.D.Mich. Filed January 4, 2023) names as defendants: Neil Chandran, a felon who ran a fraudulent scheme and his assistants: Garry Davidson, Michael Glaspie, Linda Knott, Amy Mossel, AEO Publishing, Inc., Baner Co-op and Bannersgo, LLC. The two-year scheme, which began in 2018, centered on selling interests in what was advertised as a unique blockchain technology that promised very high returns. Mr. Changran created the deal. The other Defendants contributed by selling interests in the deal which centered on a sham transaction. They also adding their personal wrinkle to the fraudulent sales pitch about the interests being marketed. Defendant Glaspie, for example, stressed the huge payouts while Defendant Knot created payout scales for potential investors. The scheme, known as CoinDeal, raised about $45 million. The complaint alleges violations of Securities Act Sections 5(a), 5(c) and 17(a) and Exchange Act Section 10(c) and 15(a). The case is pending. See Lit. Rel. No. 25608 (January 5, 2023).
SEC v. Ellison-Meade, Civil Action No. 2:23-cv-00521 (C.D. Cal. Filed January 24, 2023) is an action which names as defendant Austin Danger Ellison-Meade. Defendant is the 24 year old “managing partner” of Baycap.io. He claimed to have developed a proprietary algorithm that could identify stocks poised for growth. Over a three-year period, beginning in February 2019, he convinced 31 investors to put about $2.8 million into the firm. In fact, much of the money was misappropriated. To conceal that fact, Defendant distributed false account statements to investors. The complaint alleges violations of Securities Act Section 17(a), Exchange Act Section 10(b) and Advisers Act Sections 206(1), 206(2) and 206(4). The action is pending. The U.S. Attorney’s Office for the Central District of California filed parallel criminal charges. See Lit. Rel. No. 2:23-cv-0521 (January 24, 2023).
Crypto assets
Cases tied to crypto assets have become a key focus for the Commission in recent years. While various efforts have been made in Congress to pass new regulations, all have failed. The two examples of actions below present different aspects of the issued presented. The first, centers on a matter involving the Digital Currency Group and the Winkevoss twins, in which investors turned over their assets to a third party to be pooled for institutional lending in the hopes of profits. The second is based on a “staking program” in which investors turn over their crypto assets to the group and tied them to a blockchain in the hopes of more profits. The staking approach has been appearing in other cases recently.
SEC v. Genesis Global Capital, LLC, Civil Action No. 23-cv-287 (S.D.N.Y. Filed January 12, 2023) is an action which names as defendants: Genesis Global and Gemini Trust Company, LLC, respectively, a second tier subsidiary of Digital Currency Group, Inc. and a limited liability company controlled by Camereon and Tyler Winklevoss through Winklevoss Capital Fund, LLC. The complaint centers on what was called the Gemini Earn program. Through that program investors entered into a three-party contract under which they provided crypto assets to Genesis with Gemini serving as agent. Genesis then pooled the crypto assets which were used primarily in an institutional lending program that generated interest and profits used to pay investors. The interests sold were not registered with the Commission. Currently, U.S. investors have suffered losses. In November 2022 Genesis unilaterally announced it would not permit its 340,000 investors to make withdrawals. Genesis holds about $900 million in investor assets. The complaint alleges violations of Securities Act Sections 5(a) and 5(c). The action is pending.
SEC v. Payward Ventures, Inc., Civil Action No. 23-cv-588 (N.D. Ca. Filed February 9, 2023) is an action which names as defendants Payward Ventures and Payward Trading LTD. Defendants are collectively known as “Kraken.” The firm operated what is called a Staking Program. The program required that investors turn over their crypto assets and allow them to be tied to a blockchain. The firm then used the assets as a marketing tool in order to lure additional investors. The investor supposedly obtained benefits from letting their assets be pooled such as advertising and better rates of return than they could achieve individually. Indeed, the Kraken Stating Program touted its better rates of return. At one point the program had over $45 million from U.S. investors, among others. The complaint alleges violations of Securities Act Sections 5(a) and (c). To resolve the proceedings, Defendants consented to the entry of permanent injunctions based on Securities Act Sections 5(a) and 5(c). Each Defendant also agreed to the entry of a separate order which permanently enjoins them from participating in any staking programs in the future. In addition, Defendants agreed to pay $30 million in disgorgement, prejudgment interest and penalties. See Lit. Rel. No. 25637 (February 13, 2023).
Insider trading
Insider trading has long been a focus for the Commission. The first example of cases from the period in this area involves two cousins, employed by different firms, who harvested information from each employer, to trade. The second involved the misuse of Rule 10b-5-1 plans to try and insulate insider trading.
SEC v. Stiles, Civil Action No. 1:23-cv-01523 (S.D.N.Y. Filed February 23, 2023) is an action which names as defendants two cousins, James Andrew Styles and Edward Gary Stiles. James Andrew was employed at BDO USA, LLP as the Managing Director in the Biodefense & Government Contracts group until May 2020. Subsequently, he was employed by Phlow Corporation, a pharmaceutical company, as V.P. of Government Initiatives and Contract Compliance. Phlow was assisting Eastman Kodak Company in obtaining funding from the federal government to produce medicines focused on responding to the COVID-19 pandemic. While the funding was being negotiated, but before the information became public, James Andrew purchased Kodak stock. After the government’s interest in Kodak was disclosed, the shares were sold for $553,000. He also tipped his cousin Edward Gary Stiles who purchased shares. After the information became public the shares sold for about $990,000. While employed by BDO, James Andrew worked on matters for Novavax, a firm with a consulting contract with BDO. The company was attempting to procure over $300 million in funding to support efforts in developing a coronavirus vaccine. Before this information was disclosed James Andrew purchased shares of Novavax which were sold after the information became public. He had profits of over $45,000 on the transaction. The complaint alleges violations of Exchange Act Section 10(b). The case is pending. The U.S. Attorney’s Office for Manhattan announced parallel criminal charges. See Lit. Rel. No. 25647 (February 23, 2023).
SEC v. Peizer, Civil Action No. 2:23-cv-01511 (C.D. Calif. March 1, 2023) is an action which names as defendants Terren S. Peizer, the founder and Executive and Chairman of the Board of Ontrak, Inc., a virtualized outpatient healthcare treatment company, and his personal investment vehicle, Acuitan Group Holdings, LLC. The action centers on trading while in possession of material non-public information in the shares of Ontrak. The company is a behavioral health firm. It contracts with health plans to identify members whose chronic disease will improve with behavior change. Ontrak then provides the members with solutions. Ontrak has suffered significant losses since its founding in 2003. By March 2021 its business was dependent on three large customers, one of whom was Customer A. When that customer left, the share price of Ontrak dropped 44%. From May through August 2021 Mr. Peizer adopted two Rule 10b-5-1 trading plans. He used those two plans to sell 641,357 shares of Ontrak. At the time of the transactions Mr. Peizer knew that in August 2021 when a large customer left Ontrak — Customer A — the share price dropped significantly. He also knew prior to the adoption of the two Rule 10(b)-5-1 trading plans that another large shareholder was considering leaving Ontrak. The complaint alleges violations of Securities Act Section 17(a) and Exchange Act Section 10(b). The case is pending. The U.S. Attorney’s Office for the Central District of California filed parallel criminal charges.
Financial fraud
Financial fraud is also a long standing focus of the Commission and its enforcement program. In the first case below the executives involved engaged in a series of actions to manipulate the firm’s financial statements after it went private. In the second, pitch books were created with false information to solicit investors and at one point one of the solicitors impersonated a You Tube executive on a phone call to try and embellish the reputation of the company.
In the Matter of Roadrunner Transportation Systems, Inc., Adm. Proc. File No. 3-21301 (February 14, 2023). Respondent is a shipping and logistics firm based in Cudahy, Wisconsin. Roadrunner’s stock was listed on the NYSE and registered with the Commission. In 2020 the company filed a Form 25 withdrawing its common stock from listing. Subsequently, Roadrunner terminated its registration. Roadrunner acquired over twenty transportation firms in a seven-year period, beginning in 2010. Each company was consolidated into Roadrunner. The financial results of all the firms were consolidated into Roadrunner’s financial statements. The company manipulated its financial results over a four-year period, beginning in mid-2013, according to the OIP. Roadrunner engaged in a fraudulent scheme to conceal major expenses, hide poor performance and avoid write-offs of impaired assets. The focus of the scheme was to meet earnings goals. The scheme began when Roadrunner acquired Operating Company. The deal papers called for Roadrunner to pay the sellers an earnout that was contingent on the acquired firm’s future performance. The impact of the calculation depended on the performance of the acquired firm. Under GAAP Roadrunner was required to remeasure the fair value of the earnout at each reporting date. If the Operating Company could not meet the annual EBITDA thresholds to trigger the payment of the full earnout amount there were two effects: a) it provided a short-term boost to net income but b) a signal to investors that the acquired firm was not meeting the EBITDA projections required by the deal. To avoid the latter, the numbers were manipulated. Over a four-year period Roadrunner continued to alter certain financial metrics to avoid revealing that some properties were not performing as expected. At various times the firm hid major expenses, concealed poor performance and avoided required write-offs. In early 2017 Roadrunner announced in a Form 8-K that it had commenced an investigation. Discrepancies were uncovered and reported to the audit committee. The next year the firm announced the conclusions of the inquiry. Roadrunner terminated those responsible for the scheme, installed new controls and shared the findings from the investigation with the Commission. The Order alleges violations of Securities Act Section 17(a) and Exchange Act Sections 10(b), 13(a), 13(b)(2)(A) and 13(b)(2)(B). To resolve the proceedings, Respondent consented to the entry of a cease-and-desist order based on the Sections cited. The firm also agreed to pay disgorgement of $7,096,092 and prejudgment interest of $2,539,819.71. Payment was satisfied by paying $20 million to a parallel class action, $16 million of which was distributed to the shareholders.
SEC v. Ozy Media, Inc., Civil Action No. 23 Civ. 1424 (E.D. N.Y. Filed February 23, 2023) is an action which names as defendants: the firm, a start-up news and media company; Carlos R. Watson, Jr., formerly a registered representative, an attorney who does not practice and the CEO of Ozy; Samir Rao, formerly a registered representative and currently the COO of Ozy; and Suzee Han, chief of staff at Ozy. Over a three-year period, beginning in 2019, Defendants Watson and Ray, with assistance from others, provided materials and pitchbooks about Ozy which overstated historical, annual revenues by at least 100%. Investors were, in addition, repeatedly told that large, significant, sophisticated investors were about to put funds in the company – a false statement. In February 2021 Defendant Rao, in addition, impersonated a You Tube executive on a conference call in an effort to embellish Ozy’s business relation with You Tube and obtain a $25 million investment. Later the impersonation was reported in the New York Times. The complaint alleges violations of each Subsection of Securities Act Section 17(a) and Exchange Act Section 10(b). Defendant Rao consented to the entry of a judgment enjoining him from violating the provisions charged in the complaint and precluding him from serving as an officer/director for ten years. Defendant Han agreed to a similar entry. Monetary penalties will be determined for each defendant at a later date. The U.S. Attorney’s Office for the Eastern District of New York announced the filing of criminal charges as to each individual Defendant.
Next: Examples of other significant actions filed in the 1Q23.