This Week In Securities Litigation

by Dorsey & Whitney LLP

The fate of SEC ALJs was debated this week before the Supreme Court. Despite the fact that the Commission and Solicitor General confessed error, switched sides and joined with Petitioner to argue that historically the agency had violated the Constitution’s Appointments Clause, the Justices appeared skeptical about the resolution of the case. The Court expressed concern regarding Petitioner’s claim that the administrative proceeding in which he was found liable was not fair while arguing for a process that would make SEC ALJs more accountable to the political process, the precise test to be used in assessing the applicability of the Clause and the remedies.

SEC Enforcement filed settled cases in three of its key focus areas: Cyber security, conflicts and FCPA. The agency resolved a huge data breach case where a giant internet media issuer failed for years to disclose a massive data breach regarding what the firm called the “crown jewels.” Another action centered on undisclosed conflicts involving an investment adviser was filed. And, a third involved a settled FCPA action based on books and records and internal controls was filed.


Remarks: Commissioner Robert Jackson delivered remarks at the Greater Cleveland Middle Market Forum titled The Middle-Market IPO Tax, Cleveland, Ohio (April 25, 2018). His remarks focused on the costs of an IPO and, in particular, the costs for a mid-sized IPOs.

Supreme Court

Raymond J. Lucia v. SEC, No. 17-130 was heard this week by the Supreme Court. The question being considered centers on the Appointments Clause of the Constitution and whether SEC ALJs are Officers within the meaning of the Clause. The parties agree that the Clause creates three categories of federal civil servants: Principal Officers, Inferior Officers and employees. Principal Officers are appointed by the President with the advice and consent of the Senate; Inferior Officers (usually referred to as Officers) can be appointed under law by the President, a department head or an agency; employees can simply be hired. While SEC ALJs traditionally had been viewed as employees, when Lucia reached the Supreme Court after the D.C. Circuit rejected challenges to the SEC’s approach to hiring ALJs, the agency and Solicitor General switched sides, adopting Petitioner’s view that they are Officers. The SEC implemented a ratification process to try and correct the error confessed.

Briefs for each of the parties – Petitioner, Solicitor General and Court appointed Amicus who defended the decision below – all discussed the Court’s prior decisions at length. While each side adopted different views of what the Clause required to be an Officer, each claimed its view was consistent with the Court’s jurisprudence. The arguments did not seem to yield any clear consensus on the appropriate resolution of the dispute. Nevertheless, the decision could have wide impact on federal agency practice. A decision is expected by the end of June.

SEC Enforcement – Filed and Settled Actions

Statistics: Last week the SEC filed 2 civil injunctive case and 3 administrative proceedings, excluding 12j and tag-along proceedings.

Prohibited transaction: In the Matter of SEI Investments Global Fund Services, Adm. File No. 3-18457 (April 26, 2018) is a proceeding which names as a Respondent the statutory trust which is a wholly owned subsidiary of SEI Investments Company. From 2008 through 2012 SEI Global caused the Liquidity Fund – a vehicle for investing cash collateral from the securities lending activities of certain Funds – to fail to satisfy the conditions necessary for SEI Funds to rely on an exemption that permitted funds in certain instances to deal with affiliated funds. While SEI Global Funds priced shares of the Liquidity Fund at a stable $1 in accord with the applicable rule under the Investment Company Act, due to significant decreases in the value of certain holdings in July 2008 it adopted an alternate market based approach to price its shares. Over the next four years however, the method used was flawed. Further, in August 2009 five new SEI Funds began participating in the securities lending program. While they priced at a stable $1 this created a “senior share class” of Liquidity Fund securities which took the Liquidity Fund out of compliance with Section 18 of the Investment Company Act. In addition, having two different pricing methods was inconsistent with the rules. As a result SEI Global Caused the Liquidity Fund to violate sections 17(a)(1) and (2) from 2008 through 2012. To resolve the proceedings SEI Global consented to the entry of a cease and desist order based on the sections cited in the Order. In addition, Respondent will pay a penalty of $225,000.

Cyber security: In the Matter of Altaba Inc., f/d/b/a Yahoo! Inc., Adm. Proc. File No. 3-18448 (April 24, 2018). Yahoo was one of the largest internet media firms in the world. Its shares were traded on the NASDAQ Global Select Market. Following the sale of its operating business in July 2017 to Verizon Communications Inc., the firm changed its name to Altaba Inc. Its shares continued to be registered for trading with the Commission but as a publicly traded non-diversified, closed-ended management investment company. Altaba’s shares are traded on the NASDAQ Global Select Market. In late 2014 Yahoo suffered a massive breach of its user database. It resulted in the theft, unauthorized access, or acquisition of hundreds of millions of its users’ personal data. The firm’s internal information security team learned that the company information technology networks and systems suffered a widespread intrusion by hackers associated with the Russian Federation. By December 2014 the security team, as well as the Chief Information Security Officer, determined that the hackers had stolen copies of user database files containing the personal data of at least 108 million users. This included information called the “crown jewels” – email addresses, telephone numbers, dates of birth, hashed passwords, and security questions and answers. The hackers also accessed a separate data source – 26 Yahoo customer accounts connected to Russia. Senior management and the internal legal team received reports from the CISO within days. The firm did not disclose the information until the fall of 2017. In the interim the firm’s public filings continued to list cyber security as a significant risk and its MD&A reviewed trends without discussing the event. The firm also sold its internet business to Verizon for $4.8 billion without disclosing the breach while representing that the firm had over the years only suffered minor intrusions. Finally, on September 22, 2016, Yahoo disclosed the 2014 breach. Its stock price plunged and Verizon required that the deal be renegotiated. The Order alleges violations of Securities Act sections 17(a)(2) and (3) and Exchange Act section 13(a) and related rules. To resolve the proceedings Respondent consented to the entry of a cease and desist order based on the sections cited in the Order. The firm also agreed to pay a $35 million penalty.

Conflicts: In the Matter of WCAS Management Corporation, Adm. Proc. File No. 3-18449 (April 24, 2018) is a proceeding which names as a Respondent the registered investment adviser. Respondent is the adviser to several private equity funds. The fund clients use a group purchasing organization or GPO to secure discounts as a result of volume purchases. Under the WCAS service agreement the adviser received a rebate from the GPO. This created certain conflicts revolving around the acceptance of that payment which required the consent of the clients – the adviser could not consent because of the conflict. That is in accord with the operating agreement. Respondent failed to disclose the conflicts and obtain the consents. The Order alleges violations of Advisers Act sections 206(2) and 206(4). To resolve the proceedings Respondent consented to the entry of a cease and desist order based on the sections cited in the Order and to a censure. In addition, Respondent will pay disgorgement of $623,035, prejudgment interest of $65,784.78 and a penalty of $90,000.

Offering fraud: SEC v. Pixarbio Corp. Civil Action No. 1:18-cv-10797 (D. Mass. Filed April 24, 2018) is an action which names as defendants the firm, a biotech company with no revenue, Francis Reynolds, the firms president, Kenneth Stromsland, the CIO, and M. Jay Herod, a long time friend of Reynolds. Since at least December 2015 Defendants have raised about $12.7 million from the sale of firm shares to 211 investors. To sell the shares a series of false statements were used which included claims that: The FDA had permitted clinical trials to begin on humans; that the firm had a $10 million line of credit; that it had sufficient capital to operate through 2017; and that Mr. Reynolds had personally invested in the company. In addition, Defendants Reynolds, Herod and Stromsland essentially engaged in a pump and dump scheme using the company shares to raise another $500,000 to keep the firm afloat. The complaint alleges violations of Securities Act sections 5(a), 15(c) and 17(a) and Exchange Act sections 9(a), 10(b) and 15(a). The case is pending. See Lit. Rel. No. 1:18-cv-10797 (April 24, 2018); see also U.S. v. Reynolds, No. 1:18-mj-06151 (D. Mass. Filed Apr. 19, 2018)(criminal complaint charging Frank Reynolds and Kenneth Stromsland with securities fraud).

Investment fraud: SEC v. Glick, Civil Action No. 24118 (N.D. Ill.) is a previously filed action against investment adviser Daniel Glick and his firm, Financial Management Strategies, Inc. The action alleged that Defendants targeted elderly investors in soliciting funds from investors. Much of the investor money was misappropriated. The Commission resolved the proceedings with Defendants consenting to the entry of a permanent injunction and orders to pay disgorgement and penalties in amounts to be determined later. See Lit. Rel. No. 24118 (April 23, 2018); See also U.S. v. Glick, No. 17-cr-739 (N.D. Ill.)(Parallel criminal case in which Defendant was sentenced to serve 151 months in prison).

Financial fraud: SEC v. Davis, Civil Action No. 14-cv-01528 (S.D.N.Y.) is a previously filed action against Stephen DiCarmine and Joel Sanders, respectively the former CFO and executive director, of Dewey & LeBoeuf. Both men were alleged to have been involved with a financial fraud at the now collapsed law firm which was designed to permit the firm to meet lender covenants. The false financial information was also used in a $150 million private place of bonds. Mr. Sanders resolved the matter, consenting to the entry of a permanent injunction based on Securities Act section 17(a) and Exchange Act section 10(b). The amount of disgorgement and a penalty will be determined by the Court at a later date. Mr. DiCarmine consented to the entry of a permanent injunction based on Securities Act sections 17(a)(2). He will pay a penalty of $35,000. See Lit. Rel. No. 24119 (April 23, 2018).

Investment fraud: SEC v. Newsholme, Civil Action No. 3:17-cv-06813 (D.N.J.) is a previously filed action against financial planner Scott Newsholme. The complaint alleged that at his financial planning business the Defendant induced clients to trust him to invest their money and handle their financial affairs as directed. In fact he misappropriated their funds. Defendant resolved the action by consenting to the entry of a permanent injunction based on Securities Act section 17(a), Exchange Act section 10(b) and Advisers Act sections 206(1) and (2). The judgment also requires him to pay disgorgement, prejudgment interest and penalties in amounts to be determined later. In a parallel criminal action Mr. Newsholme pleaded guilty to wire fraud, aggravated identity theft and aiding and abetting filing false tax returns. He is awaiting sentencing. See Lit. Rel. No. 24120 (April 23, 2018).

Criminal Cases

Front running: U.S. v. Johnson, No. 16-cr-457 (E.D.N.Y.) is an action in which Mark Johnson, the former head of HSBC’s Global Foreign Exchange Cash Trading was sentenced to serve 24 months in prison and pay a $300,000 fine. Mr. Johnson had been convicted of wire fraud and wire fraud conspiracy following a four week trial. The case was based on trades in late 2011 during which HSBC had been retained to convert about $3.5 billon into British Pounds Sterling. The client had required strict confidentiality. Shortly before the transaction was to take place Mr. Johnson and those under him traded in the currency in a manner that inflated the price for the benefit of the firm and to the detriment of the client. The resulting profits for HSBC were about $7.3 million. I

Insider trading: U.S. v. Chow, No. 1:17-cr-00667 (S.D.N.Y.) names as a Defendant Benjamin Chow, the managing director of one hedge fund and the managing partner of another. The two hedge funds with which Mr. Chow was affiliated entered into a transaction to acquire Lattice Semiconductor Corporation in the fall of 2016. While the transaction was being negotiated Mr. Chow repeatedly told his friend about the transaction. The friend traded, reaping profits of about $5 million. Mr. Chow was charged with conspiracy and securities fraud. Following trial a jury found Mr. Chow guilty of one count of conspiracy and seven counts of securities fraud. Sentencing is scheduled for August 20, 2018.


In the Matter of The Dun & Bradstreet Corporation, Adm. Proc. File No. 3-18446 (April 23, 2018). D&B manages a global business providing reliable credit information. Its shares are listed on the New York Stock Exchange. Critical to the firm’s business model is the continual acquisition of credit profiles and other related information. It is essential that its data bases remain current. The firm first entered the market in China in the early 1990s through a joint venture. Over time that business approach was modified. In 2006 the President of the Asia-Pacific region established a relationship with Huaxia International Credit Consulting Co. Limited. Ultimately a joint venture was formed between D&B’s Chinese subsidiary and Huaxia. D&B owned 51%.

Huaxia was targeted because of its government connections. The firm was able to source financial statement information directly from provincial offices of the Chinese State Administration of Industry and Commerce, the Chinese National Bureau of Statistics, lawyers and other individuals rather than public sources. Following the completion of the deal D&B Greater China management and staff were aware that it was possible to obtain such information through illicit arrangements. This continued until mid-2012 when the firm’s Shanghai based subsidiary eliminated improperly obtained financial statement data from its information products as a remedial measure.

In June 2009 D&B entered into a business arrangement with Roadway, a Chinese firm that was ultimately acquired by a subsidiary. Roadway was a leading provider of direct marketing services in China. D&B identified as a key risk of this acquisition the February 2009 amendments to the Chinese criminal laws concerning citizens’ data privacy. Essentially those amendments criminalized the acquisition of a citizen’s personal information through theft or certain other means. Roadway had, according to what D&B learned, significant amounts of such data from independent vendors. The firm continued to acquire this type of data and, in a March 15, 2012 television broadcast, discussed its data collection. This lead to the seizure of the firm’s servers by government prosecutors, the conviction of the firm and several executives on criminal charges and the payment of a criminal fine.

Subsequently, D&B self-reported to the DOJ and the SEC. The DOJ declined to prosecute. The Order alleges violations of Exchange Act sections 13(b)(2)(A) and 13(b)(2)(B). In resolving the matter the Commission considered the remedial actions of D&B which included ceasing the Roadway operations and illicit practices, terminating certain employees, disciplining others and re-evaluating and supplementing its anti-corruption compliance programs.

To resolve the matter D&B consented to the entry of a cease and desist order based on the sections cited in the Order. In addition, the firm will pay disgorgement of $6,077,820, prejudgment interest of $1,143,664, and a penalty of $2 million.

Hong Kong

Compliance: The Securities and Futures Commission sanctioned CN Capital Management Limited and two of its executives, George Chan and Stephen Ng. Specifically, the firm was reprimanded and fined $1 million while the executives were fined $100,000 each. The sanctions were imposed for breaches of the Fund Manager Code of Conduct and basic principles of management and not avoiding conflicts. The SFC investigation concluded that beginning in January 2011, and continuing through October 2016, none of the firm staff members disclosed their personal investment holdings to the firm in writing, Messrs. Chan and Ng conducted thousands of personal trades without any written pre-clearance from the designated officer, in numerous instances the two executives held their personal investments for less than thirty days without prior written approval and in a number of instances the two men conducted personal trades in the same stock on the same day as those placed by the fund. In resolving the case the regulator considered the cooperation give, the lack of evidence of front running and the fact that there was no evidence of client impact.

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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