This Week In Securities Litigation

by Dorsey & Whitney LLP

The SEC settled another action this week based on admissions of fact and that the Federal securities laws were filed, this time involving Oppenheimer. The action was based on the fact that the firm permitted an off-shore and non-U.S. broker to use its account to engaged securities transactions with its customers. It also permitted the sale of unregistered penny stocks by a customer. Oppenheimer settled at the same time with FinCEN for failing to file a SAR.

The Commission also brought an action against a community bank focused on claims that it failed to properly account for the diminution in value of certain securities held in its portfolio, an investment fund fraud action and a case centered on a prime bank fraud.


Remarks: Commissioner J. Christopher Giancarlo addressed the Commodity Markets Council, Miami Florida. His remarks were titled End-Users Were Not the Cause of the Financial Crisis: Stop Treating Them Like They Were (Jan. 26, 2015). His remarks focused on the burdens imposed on end-users by Dodd-Frank (here).

SEC Enforcement – Filed and Settled Actions

Statistics: During this period the SEC filed 1 civil injunctive action and 5 administrative proceedings, excluding 12j and tag-along-actions.

Unregistered broker: In the Matter of International Capital Group, LLC, Adm. File No. 3-16366 (Jan. 29, 2015) is a proceeding which names as Respondents the firm, a stock based lender, Brian Nord, its managing partner, Larry Russell Jr., a co-founder of the firm, and Todd Bergeron, a managing partner. Over a two year period beginning in 2008 the firm sold over 9 billion shares of microcap stock yielding about $62 million. The stock had been obtained as collateral for loans and frequently was sold shortly after the agreement was completed. On multiple occasions the firm sold shares that were not registered. The Order alleged violations of Securities Act Sections 5(a) and (c) and Exchange Act Section 15(a). Each Respondent settled, consenting to the entry of a cease and desist order based on the Sections cited in the Order. The firm was also censured. The firm and Messrs. Nord and Russell will jointly and severally pay disgorgement of $1,466,595 along with prejudgment interest. The firm will also pay a civil penalty of $1.5 million while Messrs. Nord and Russell will pay, respectively, penalties of $150,000 and $125, 000. Mr. Bergeron will pay a civil penalty of $150,000. In addition, the firm consented to the entry of a penny stock bar. Messrs. Nord and Russell will be barred from the securities business and from participating in any penny stock offering with a right to apply for re-entry after 5 years. Mr. Bergeron is subject to the same bar but with a right to apply for re-entry after 3 years.

Investment fund fraud: SEC v. Holzhueter, Case No. 15-cv-00045 (W.D. Wis. Filed Jan 29, 2015) is an action which names as defendants Insurance Service Center, an insurance brokerage firm, and its owner, Loren Holzhueter. The complaint alleges that the defendants raised over $10.4 million from about 120 investors since 2008 who were told their funds would be put in separate investment accounts and used to expand the business. In fact the funds were used to operate the firm and channeled off to other purposes. The complaint alleges violations Securities Act Section 17(a) and Exchange Act Section 10(b). The Court entered a temporary freeze order. The case is pending. See Lit. Rel. No. 23182 (Jan. 29, 2018).

Income inflation: SEC v. Lyndon, Civil Action No. CV 13 00485 (D. Haw.) is a previously filed action which named as defendants Troy Lyndon and Ronald Zaucha. The complaint alleged that Mr. Lyndon, the founder of religious themed video game manufacturer, Left Behind Games, Inc., and his friend Ronald Zaucha, falsely inflated the revenue of the firm. The Court granted summary judgment in favor of the Commission. Mr. Zaucha was permanently enjoined from violating the antifraud and registration provisions of the securities laws, barred from participating in any penny stock offering and ordered to pay $2.6 million in disgorgement, interest and penalties. See Lit. Rel. No. 23181 (Jan. 29, 2015).

Financial fraud: In the Matter of Laurie Bebo, Adm. Proc. File No. 3-16293 (Jan. 29, 2015) is a previously filed action naming as Respondents Laurie Bebo, formerly the president of Assisted Living Concepts, Inc., and Jon Buono, the firm’s senior vice president and treasurer. The action centered on a financial fraud at the firm detailed (here). Ms. Bebo previously sued the SEC, claiming the action should have been filed in Federal district court (here). Mr. Buono settled with the Commission, consenting to the entry of a cease and desist order based on Exchange Act Sections 10(B), 13(A), 13(B)(2)(A) and 13(b)(2)(B). He also agreed to be barred from acting as an officer or director and will pay a penalty of $100,000.

Financial fraud: In the Matter of First National Community Bancorp Inc., Adm. Proc. File No. 3-16363 (Jan. 28, 2015). First National held a portfolio of investment securities valued at $273.6 million at year end 2009. If the securities decline in value below amortized cost, the Bank was required to assess if the decline it is other than temporary. If value of cash flows expected to be collected from the security is below amortized cost the amount must be recognized in the statement of operations. To measure the amount to be recognized GAAP requires that an estimate of expected future cash flows be made. Frequently financial institutions retain consultants to create a model. The assumptions in the model are critical. The model selected relied on unreasonable assumptions, according to the Order, regarding future cash flows and the timing of liquidation of the collateral related to issuers that had deferred or defaulted. Mr. Lance never inquired about the assumptions used in the model and was thus unable to assess whether they were reasonable in view of the circumstances. As a result of failing to establish and maintain the appropriate accounting policies and procedures to ensure that the bank properly calculated the other-than temporary impairment, the bank reported materially misstated amounts in its year-end financial statements and for the first two quarters of the next year. Ultimately the firm was required to restate its financial statements. The Order alleged violations of Securities Act Section 17(a)(2) and Exchange Act Sections 13(a), 13(b)(2)(A) and 13(b)(2)(B). The bank resolved the matter, consenting to the entry of a cease and desist order based on the Sections cited. It also agreed to pay a penalty of $175,000. Mr. Lance consented to the entry of a cease and desist order based on the books and records provisions cited in the Order. He also entered into an undertaking to pay a penalty of $20,000.

Unregistered broker: In the Matter of Oppenheimer & Co., Inc., Adm. Proc. File No. 3-16361 (Jan. 27, 2015). The proceeding has two key parts. The first focuses on the period July 2008 through May 2009. During that period the firm executed the sale of millions of shares of penny stocks for Gibraltar Global Securities, Inc., a broker-dealer registered in the Bahamas but not the United States. Despite the fact that the Gibraltar account was in the name of the firm, the Order states that Oppenheimer knew the broker was actually executing transactions and providing brokerage services for its customers. By falsely representing to Oppenheimer that they transaction in the account were belong to them Gibraltar sheltered its clients from withholding taxes but since Oppenheimer knew or should have know the claim was not true it became liable for them. Oppenheimer failed record this liability making its books and records inaccurate. The firm also failed to file SARS. As a result of the rapid deposit and withdraw of, respectively, large amounts of penny stocks and cash, the firm was aware of suspicious activity. That triggered an obligation to file a SAR. Oppenheimer failed to make the requisite filings. As a result of these activities Oppenheimer violated Exchange Act Sections 15(a) and 17(a) and the related rules.

The second part of the action focuses on the period October 2009 through December of the next year. During that period a client of the firm deposited large amounts of penny stocks in its account for six companies. In total over 2.5 billion shares were deposited in the account. The transactions yielded $12 million in proceeds and just under $600,000 in commissions. There were no registration statements and the firm ignored a series of red flags related to the issue. As part of the resolution of the case the firm agreed to implement a series of undertakings including the retention of an independent compliance consultant who will prepare a report with recommendations which will be adopted. The firm also consented to the entry of a censure and a cease and desist order based on the Sections cited in the Order. Oppenheimer will pay disgorgement of $4,168,400, prejudgment interest and a civil penalty in the amount of $5,078,129 which, together with the disgorgement and prejudgment interest, totals $10 million, the same amount paid to resolve proceedings with FinCen.

Offering fraud: In the Matter of Spectrum Concepts, LLC, Adm. Proc. File No. 3-16356 (Jan. 23, 2015) is a prime bank fraud action which names as Respondents Spectrum, a vehicle used in the transactions; Donald Worswick, the president and owner of Spectrum; Michael Grosso, previously a nutritionist and fitness trainer; and Michael Brown who claimed to be an attorney but in fact was not. The scheme was orchestrated by Mr. Worswick and Spectrum with assistance from Messrs. Grosso and Brown. Over several months in 2012 the Respondents sold about $465,000 of investments in a “Private Joint Venture Credit Enhancement Agreement” to at least five elderly investors. Investors were told their funds would be invested in a variety of items including private funding projects used to set up a credit facility and a trade slot that would be blocked for the benefit of a trade platform. A number of investors were promised the full return of their capital in addition to returns on their investment. Those returns supposedly ranged from 900% in 20 days to as much as over 4,600% annually. The investments were fictitious, according to the Order. While some investors were able to obtain a refund after changing their mind, others had their funds misappropriated. The Order alleges violations of Securities Act Sections 5(a) and (c) and 17(a) and Exchange Act Section 10(b). The proceeding will be set for hearing.

Prime bank fraud: In the Matter of David B. Havanich, Jr., Adm. Proc. File No. 3-16354 (Jan 23, 2014) is an offering fraud action. The scheme was allegedly conducted by Respondents: David Hananich, the co-founder and president of Diversified Energy Group, Inc. and the president and director of St. Vincent de Paul Children’s Foundation, Inc., a non-operating non-profit corporation; Carmine DeLLaSala, a co-founder and director of Diversified; and Matthew Welch, an officer of Diversified. They were assisted by Hampton Scurlock, RTAG Inc., a registered investment adviser owned by Mr. Welch, Jose Carrio, Dennis Karaski, Carrio, Karasik & Associates LLP and Michael Salovay. About $17.4 million was raised from 440 investors over a six year period beginning in 2006. Investors were told that Diversified invested in fractional interests in oil and gas production properties and commodities trading. A portion of investor funds were also used to purchase interests in oil and gas wells, cattle, a device to increase gas mileage and real estate. Misrepresentations were made to investors. Those included misstatements regarding Diversified’s financial performance, its use of industry experts and technologies and the affiliation of certain officers with St. Vincent’s charity which did not operate. The interests sold were not registered. The agents retained beginning in 2009 to sell Diversified bonds were not registered. Those agents were paid 5% to 10% of the investor proceeds. Despite receiving an email and other correspondence from Diversified’s outside counsel detailing the limits on the firm’s use of unregistered agents, sales by agents continued. Collectively those agents earned about $985,000. The Order alleges violations of Securities Act Section 17(a) and Exchange Act Sections 10(b) and 15(a). The matter will be set for hearing.

DISCLAIMER: Because of the generality of this update, the information provided herein may not be applicable in all situations and should not be acted upon without specific legal advice based on particular situations.

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