Chairman Clayton announced an outreach to retail investors, offering to meet with them in select cities over the next few weeks to discuss their investment experience. The initiative is the latest effort by the Commission to focus on retail investors.
Enforcement actions brought during the holiday shortened week also reflect the retail investor focus of the agency. One offering fraud action, for example, involved a firm that was so successful in selling notes and lending the proceeds to developers that its ability to service the notes sold was impaired ultimately resulting in a misuse of investor funds. Another action involved an international chemical firm centered on a failure to disclose certain items in the compensation section of the firm’s proxy materials because of an incorrect interpretation of the applicable requirements. Two other actions also involved compliance issues. One charged an investment adviser who failed to adequately implement procedures to prevent a misappropriation of funds from a group of accounts. Another involved a broker’s failure to properly implement procedures regarding unauthorized transactions. And, a case charging the sale of unregistered securities was brought against an attorney and his law firm manager tied to purchases of shares whose value skyrocketed following the addition of the word “blockchain” to its name.
Finally, the Commission settled tow FCPA cases. One involved an international financial institution and the retention of employees referred by government officials in return for future business. A second centered on an international spirits seller and its improper payments in India to secure certain competitive advantages.
Investors: The Commission announced that Chairman Clayton has invited main street investors to meet with him on four different dates at different locations in July 2018 to discuss their investor experience.
SEC Enforcement – Filed and Settled Actions
Statistics: Last week the SEC filed 4 civil injunctive cases and 7 administrative proceedings, excluding 12j and tag-along proceedings.
Insider trading: SEC v. Molina, Civil Action No. 3:18-cv-01748 (N.D. Tx. Filed July 5, 2018) is an action which names as a defendant Nelson Molina, formerly the senior vice-president of investor relations and treasury for ClubCorp Holdings, Inc., a membership based leisure business. During the course of his employment Mr. Molina learned that his employer was exploring strategic alternatives which included the possible sale of the firm. In late October, 2016 he purchased shares of the firm through three brokerage accounts he controlled. In mid-January 2017 a news service reported that ClubCorp was exploring a sale of the company. Subsequently, the company acknowledged that it was exploring alternatives in a press release. The stock price increased almost 16%. Mr. Molina continued to hold his shares, selling in May and June 2017. He had trading profits of over $78,000. After receiving an inquiry from FINRA following the initial news reports and a call from his firm Mr. Molina acknowledged his conduct, resigned his position and self-reported to the SEC. The complaint alleges violations of Exchange Act section 10(b). To resolve the case, Defendant consented to the entry of a permanent injunction based on the section cited in the complaint. He also agreed to pay disgorgement and a penalty of $39,230, half of his trading profits. See Lit. Rel No. 24186 (July 6, 2018).
Offering fraud: SEC v. United Development Funding III, LP, Civil Action No. 3:18-cv-01735 (N.D. TX Filed July 3, 2018) is an action which names as defendants Funding III, whose limited partnership interests are registered with the Commission; United Development Funding IV, whose shares were listed on NASDAQ; Hollis Greenlaw, CEO of UMTH Land Development LP which is the general partner of Funding III and the asset manager of UDF IV; Benjamin Wissink, president of UMTH; Theodore Etter, executive v.p. of UMTH; Cara Obert, CFO of UMTH; and David Hanson, CAO of UMTH. Beginning in 2006 Defendants raised substantial amounts of capital from private investors, and developed a successful track record in connection with selling interests which funded land developers while paying investors returns of 8% to 9.7% By 2009 substantial loans had been made to developers. Two years later there was insufficient capital to make the investor payments. Defendants began transferring investor funds between entities to make the investor payments. Developer loans halted. Investors were not told the actual use of their cash. Nor were the asset values of the entities written down in accord with GAAP as the noted became impaired. The complaint alleges violations of Securities Act sections 17(a)(2) and (3) and Exchange Act sections 13(a), 13(b)(2)(A), 13(b)(2)(B) and rule 13a-14. To resolve the action Defendants Wissink, Etter and Obert each consented to the entry of a permanent injunction based on the sections but not the rule cited in the complaint and to the payment of $8.2 million in disgorgement, prejudgment interest and civil penalties. Mr. Hanson also agreed to pay a $75,000 civil penalty while Messrs. Greenlaw and Obert will, in addition, be enjoined from violating Exchange Act rule 13a-14. See Lit. Rel. No. 24184 (July 3, 2018).
Proxy disclosures: In the Matter of The Dow Chemical Company, Adm. Proc. File No. 3-18570 (July 2, 2018) is a proceeding which names the chemical giant as a Respondent. From 2011 through 2015 the firm did not ensure that $3 million in perquisites were adequately evaluated and disclosed as other compensation in the Compensation Discussion & Analysis section of the annual proxy statement. Under the applicable standard an item is not a perquisite or personal benefit if it is integrally and directly related to the performance of the executive’s duties. It is a perquisite if it confers a direct or indirect benefit that has a personal aspect even if it may be provided for some business reason or convenience of the company. Here Dow applied a standard where if the item had a business purpose related to the executive’s job it was not considered a perquisite. That is the standard the Commission rejected in adopting the rules. The Order alleges violations of Exchange Act sections 13(a) and 14(a). To resolve the matter the company consented to the entry of a cease and desist order based on the sections cited in the Order. The firm will also comply with its undertakings which include the retention of an independent consultant and pay a penalty of $1.75 million.
Offering fraud: SEC v. Moody, Civil Action No. 3:18-cv-00442 (E.D.VA. Unsealed July 2, 2018) is an action against Edward Moody and his advisory firm. Defendants raised about $4.95 million from 60 individuals based on claims that Mr. Moody had a successful track record as an investment adviser. Rather than invest the money as represented, Mr. Moody diverted it to his own use and used portions to make Ponzi type payments. The complaint alleges violations of Securities Act section 17(a), Exchange Act section 10(b) and Advisers Act sections 206(1) and 206(2). The court entered a freeze order and other emergency relief. See Lit. Rel. No. 24184 (July 3, 2018).
Unregistered securities: SEC v. Jesky, Civil Action No. 18 Civ. 5980 (S.D.N.Y. filed July 2, 2018) is an action which names as defendants attorney T. J. Jesky and the manager of Mr. Jesky’s law firm, Mark Destefano. UBI Blockchain Internet Ltd. was a shell company for a number of years. In early 2017 the firm announced it was in a new business related to blockchain technology. In October Defendants arranged to receive a block of shares in return for services. Those services including the preparation of a registration statement requiring the shares to be sold at $3.70 per share. Inexplicably, in November the firm’s share price increased from about $4 to $115 per share. Once the registration statement was declared effective in December 2017, Defendants sold their shares at prices that far exceeded the one specified in the registration statement, with Mr. Jesky obtaining proceeds of $766,036 and Mr. DeStefano $798,473. The complaint alleges violations of Securities Act sections 5(a) and 5(c). Each Defendant settled, consenting to the entry of a permanent injunction based on the sections cited in the complaint. Together they agreed to pay disgorgement of about $1.4 million and penalties of $188,682.
Accounting: In the Matter of KBR, Inc., Adm. Proc. File No. 3946 (July 2, 2018) is a proceeding which names the firm, a global engineering, construction and services company, as a Respondent. KBR restated its consolidated financial statements for the fiscal year ended December 31, 2013 and its unaudited consolidated financial statements for the third quarter of 2013 in a filing made with the Commission in May 2014. The restated earnings resulted from charges of $156 million, primarily tied to its Canadian business unit which did not make accurate and reliable estimates. Those estimates related to the costs to complete seven pipe fabrication and modular assembly contracts. In fact the firm had grown rapidly in Canada and did not have sufficient resources to properly prepare the estimates. In the second quarter of 2012 the firm included $459 million in its disclosed backlog for a certain energy company. At the time KBR had yet to receive any orders under the contract. The agreement remained in place during the next six quarters over which it became clear that KBR would receive far fewer work authorizations than anticipated. The disclosed backlog for the contract was thus not consistent with the disclosed backlog policy which attributed the backlog to firm orders. As such backlog was an important number to investors, serving as an indicator of future revenue. Yet, the firm’s backlog reports were overstated as filed. The Order alleges violations of Securities Act sections 17(a)(2) and (3) and Exchange Act sections 13(a), 13(b)(2)(A) and 13(b)(2)(B). In determining to accept the offer of settlement the Commission considered the cooperation of KBR and its remedial efforts which included clawing back excess compensation based on the inflated metrics. To resolve the proceedings the firm consented to the entry of a cease and desist order based on Securities Act sections 17(a)(2) and (3) and Exchange Act sections 13(a), 13(b)(2)(A) and 13(b)(2)(B).
Financial fraud: SEC v. Axesstel, Inc., Civil Action No. 18 cv 1486 (S.D. CA. Filed June 28, 2018) is an action which names as defendants: The firm, which manufactures and sells wireless broadband telecommunications and security alert systems, Patrick Gray, the CFO, Harold Hickock, the CEO and Steven Sabin, Director of Contract Fulfillment. During the fourth quarter of 2012 and the first quarter of 2013 Defendants engaged in fraudulent accounting practices which materially inflated revenue by about 66% in the fourth quarter and 38% in the first quarter by recording false sales orders known as “holding POs” and at times entering into undisclosed side agreements with customers relieving them of their obligations to pay. During the scheme false information was given to the audit committee which eventually was given to the auditors. The complaint alleges violations of Exchange Act sections 10(b), 13(a), 13(b)(2)(A), 13(b)(2)(B) and 13(b)(5). Defendants resolved the charges, consenting to the entries of permanent injunctions. In addition, Messrs. Gray, Hickock and Sabin will pay penalties of, respectively, $40,000, $25,000 and $10,000. Messrs. Hickock and Gray are also barred from serving as an officer or director of a public company, but Mr. Gray has the right to reapply after five years. Mr. Gray, in addition, consented to the entry of an order suspending him from appearing or practicing before the Commission as an accountant. See Lit. Rel. No. 24181 (July 2, 2018).
Municipal offerings: SEC v. Malachi Financial Products, Inc., Civil Action No. 24181 (S.D. Miss.) is a previously filed action against the municipal advisor and its principal, Porter Bingham. The complaint alleged that Defendants defrauded the City of Bingham in connection with an offering by submitting a false invoice for services not preformed and by not disclosing that a recommendation regarding an underwriting firm was made based on an undisclosed payment received from an employee of the potential underwriter. Defendants each consented to, and the Court entered, permanent injunctions based on Exchange Act section 15B(a)(5) and MSRB Rule G-17. Defendants will pay, on a joint and several basis, disgorgement of $33,000 and prejudgment interest of $2,858. Defendant Malachi will also pay a penalty of $50,000 while Mr. Bingham will pay $25,000. See Lit. Rel. No. 24182 (July 2, 2018).
Compliance: In the Matter of Morgan Stanley Smith Barney LLC, Adm. Proc. File No. 3-18566 (June 29, 2018) is an action which names as a Respondent the dual registered investment adviser and broker-dealer. Beginning in about December 2015, and continuing for about the next year, firm employee Barry F. Cornell initiated 110 unauthorized transactions totally about $7 million from a group of accounts. Mr. Cornell, who served as the FA on the accounts and had discretion, misappropriated $5 million through the transactions. In executing the transactions Mr. Connell falsely represented to an assistant that he had obtained verbal conformation from the clients. At the time firm policies and procedures permitted its FAs to initiate third party disbursements based on oral confirmation for $100,000 or less per day. While a review was conducted by the Service Review Unit, there was no procedure for authenticating or confirming that the client had initiated the transaction. Client generated complaints eventually triggered an internal investigation which discovered the malfeasance. The firm self-reported, remediated the procedures and entered into a settlement which the clients, fully reimbursing them. The Order alleges violations of Advisers Act section 206(4). To resolve the proceedings Morgan Stanley agreed to implement a series of undertakings focused on certifying compliance with certain policies and procedures relating to preventing or detecting the kind of activity here. Respondent consented to the entry of a cease and desist order based on the section cited in the Order. The firm also agreed to pay a penalty of $3.6 million.
Compliance: In the Matter of Alexander Capital, L.P. Adm. Proc. File No. 3-18561 (June 29, 2018) names as a Respondent the New York broker-dealer. Over a two year period beginning in 2012 the firm failed to reasonably implement certain policies and procedures related to its supervisors and the monitoring of suitability, turn-over in accounts, churning and unauthorized trading. Specifically, during the period three registered representatives engaged in improper activities with regard to customer accounts. Supervisory personnel failed to head red flags (see related proceedings cited below). The firm’s policies and procedures contained sections discussing each of the points at issue here. Supervisors were required to monitor the suitability requirements and documentation related to the recommendation. Supervisors were also required to ensure that all transactions were reviewed in such a manner as to reasonably detect and deter any instances of illegal churning in customer accounts which was strictly prohibited. In addition, supervisors were charged with overseeing trading and preventing unauthorized transactions. While the firm policies and procedures contained these provisions, they were not properly implemented, resulting in the failure to identify inappropriate practices in customer accounts. If “Alexander Capital had reasonably developed systems to implement the firm’s policies and procedures regarding reasonable basis and customer-specific suitability, churning and unauthorized trading, it is likely that the firm would have prevented and detected the violations of the federal securities laws. . .” by its employees the Order found. In resolving these proceedings the Commission considered the cooperation of Respondent. Respondent agreed to implement a series of undertakings centered on retaining an independent compliance consultant who will review the firm’s policies and procedures and prepare a report. The firm is censured and agreed to pay disgorgement in the amount of $193,774.86, prejudgment interest of $23,436.78 and a penalty equal to the amount of the disgorgement. See also In the Matter of Philip A. Noto II, Adm. Proc. File No. 3-18562 (June 29, 2018)(proceeding alleging failure to supervise by firm registered representative regarding two employees who engaged in the underlying violations; resolved with an order barring Responding from serving in a supervisory capacity and the payment of a $20,000 penalty); In the Matter of Barry T. Eisenberg, Adm. Proc. File No. 3-18563 (June 29, 2018)(proceeding naming branch manager who supervised one of the employees involved in underlying violations; resolved with limitation on right to serve as a supervisor with right to reapply after five years and payment of a $15,000 penalty).
In the Matter of Credit Suisse Group AG, Adm. Proc. File No. 3-18571 (July 5, 2018) is a proceeding which names as a respondent the Swiss based multinational financial services firm. The proceedings center around the firm’s relationship hiring practices in the Asia-Pacific region beginning as early as 2007. In that year the firm’s anti-corruption policies recognized the dangers of, and had provisions concerning, the hiring of relatives of government officials. Nevertheless, Creddit Suisse senior managers in the Asia Pacific area at times agreed in principle to, and did hire, employment candidates referred by state owned enterprises. In seeking to promote the candidacy of such a person the senior managers would highlight not the possible skills of the candidate but business relationships of the person that would be advantageous to Credit Suisse. A number of candidates were offered full-time salaried positions and paid internships that were eligible for bonuses and other benefits without having them approved and vetted through the proper compliance channels. Stated differently, in retaining referral individuals, the firm repeatedly deviated from its established, merit based practices. Firm managers in the U.S. were aware of these practices and often complained about the quality of the candidates retained. Overall more than 100 individuals referred by, or who had some connection to Asia Pacific area foreign officials, were retained. Those included over 60 employees and interns referred by foreign government officials at more than 20 Chinese SOEs. The scheme netted Credit Suisse at least $46 million. The Order alleges violations of Exchange Act sections 30A, 13(b)(2)(A) and 13(b)(2)(B). To resolve the proceedings the firm consented to the entry of a cease and desist order based on the sections cited in the Order. The firm also agreed to pay disgorgement of $29,989,843 and prejudgment interest of $4,833,961. In accepting the offer of settlement the Commission considered the remedial efforts of the firm.
Credit Suisse also resolved FCPA charges with the Department of Justice by entering into a non-prosecution agreement and agreeing to pay a criminal a criminal penalty of $47 million. In reaching that resolution the DOJ did not give the firm full credit because its cooperation was reactive and not proactive. Credit Suisse did not self-report and it failed to sufficiently discipline employees who were involved in the conduct. The firm’s cooperation did earn it a discount of 15% off the bottom of the U.S. Sentencing Guidelines fine range.
In the Matter of Beam Inc., Adm. Proc. File No. 3944 (July 2, 2018) is a proceeding which names as a Respondent the global spirits firm which was a public company until its acquisition in 2014 by a Japanese firm. Following the acquisition of a firm in India in 2006, and continuing until the third quarter of 2012, Beam, through its subsidiary, sold liquor products in six markets where the government regulated both the distribution and retail sales of alcoholic products. During the period the subsidiary used third-party promoters to market products in the government channel. With the knowledge and agreement of the subsidiary, those promoters directed improper payments to government officials at retail stores and depots to secure orders for product and good placement of items in retail stores. Prior to its acquisition by Beam, the subsidiary had engaged in similar conduct. During the same period improper payments were made to expedite the processing of annual label registrations and for warehouse licenses.
In 2011 Beam India sought to introduce the firm’s new Ready to Drink products. Label registration stalled for several months. Eventually it moved forward after an official was paid the equivalent of a year’s salary, about $18,000.
Despite discovering evidence of wrongful conduct in 2011, Beam delayed taking steps to effectively remediate the wrongful conduct for a period. Initially, Beam engaged a global accounting firm, and later a U.S. law firm to conduct compliance reviews. Both discovered improper conduct. The company then retained a local firm to further assess the matter. The local firm discovered portions of the misconduct. Following additional work by the U.S. law firm the company finally self-reported and conducted the necessary remediation. The Order alleges violations of Exchange Act sections 13(b)(2)(A) and 13(b)(2)(B).
To resolve the proceedings the firm consented to the entry of a cease and desist order based on the sections cited in the Order. Respondent also agreed to pay disgorgement of $5,264,340, prejudgment interest of $917,498 and a penalty of $2 million. In accepting the offer of settlement the Commission considered the fact that the firm self-reported, cooperated with its investigation and took a number of remedial steps.
Representations: The Australian Securities & Investments Commission settled claims related to certain representations made by Goldman Sachs Australia Pty Ltd in connection with a book building transaction for Healthscope Limited on November 23, 2015. The transaction is the process of generating, recording and capturing demand from potential investors for a capital raising. GS Australia undertook to conduct an internal review of policies, procedures, systems, controls, training, guidance and the monitoring of supervision involved in book building or the underwriting process and implement changes to address any deficiencies. The undertaking is enforceable and was accepted in place of a civil administrative action. The firm will also make a community benefit payment of $500,000.
Consultation/AML: The Securities and Futures Commission launched a consultation on proposals to amend the guideline on anti-money laundering and counter-terrorist financing to keep it in line with internal standards. Specifically, the regulator is considering amendments to expand the types of politically exposed persons to include customers who have been entrusted with a prominent function by an international organization. Another proposal focuses on streamlining the identification and verification processes for onboarding customers to permit flexibility for licensed corporations to adopt reasonable risk-based measures. Comments are requested by August 9, 2018.
Market access: The Securities and Futures Commission welcomed new CSRC rules to facilitate mainland China investors and fund managers’ access to SFC licensed firms. The rules give mainland investors who participate in the Hong Kong market better access to pertinent information.