Jay Clayton was confirmed by the Senate this week and sworn in as the new SEC Chairman. This gives the agency three Commissioners, although Commissioner Stein’s term ends in June. If the President does not appoint another Commissioner who is confirmed by the Senate before that time the agency will be back to two Commissioners. Chairman Clayton may, however, begin filling some of the open senior staff positions.
A new report on SEC enforcement activity notes that for the first half of FY 2017 the number of cases filed declined. The Commission brought a series of enforcement actions this week including two financial fraud cases; a failure to supervise action against Barclays based on misrepresentations and improper mark-ups at one of its trading desks; and another action centered on an EB-5 project.
The U.K. Serious Frauds Office announced corruption charges against a subsidiary of a German multinational. The Office also announced a corruption investigation involving the U.K. subsidiary of KBR.
Whistleblowers: The Commission awarded more than $500,000 for a report that uncovered “well hidden” conduct that resulted in an enforcement action.
SEC Enforcement – Statistics
A report on SEC enforcement activity shows a significant decrease in the number of enforcement actions brought in the first half of fiscal 2017. The Report is a joint effort of the New York University Pollack Center for Law & Business and Cornerstone Research based on their jointly operated Securities Enforcement Empirical Database or SEED (here). During FY 2017 to date the SEC has filed a total of 334 enforcement actions (excluding tag-alongs), according to the Report. This contrasts with the 372 enforcement actions filed during the comparable period one year earlier. The decline also contrasts with the trend in filing enforcement actions since at least 2013. In that year 279 enforcement actions were brought while the next year there were 310 enforcement actions filed followed by 372 in the first half of 2015. In addition, the statistics chronicle a drip in the number of insider trading and FCPA cases initiated during the same period, consistent with the overall trend. In contrast, there were increases in the number of enforcement actions filed concerning broker-dealers, issuer reporting and disclosures and those involving securities offerings. Those increases were not sufficient to offset declines in other key areas however.
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.
Offering fraud: SEC v. Schantz, Civil Action No. 1:17-cv-03115 (D. N.J. Filed May 4, 2017) names as defendants William Schantz, the founder of Defendant Verto Capital Management LLC, which sells securities to accredited investors and invests in bundles of life settlements. Over a two year period, beginning in November 2013, defendants marketed about $12.5 million in nine month promissory notes at 7% to 80 investors. Those investors were induced to invest in the notes through misrepresentations about the past profitability of the companies and regarding the use of the offering proceeds. Those proceeds were supposed to be used to fund the purchase and sale of life insurance policies on the secondary market – life settlements. Much of the money went to Mr. Schantz, however, while other portions were used to repay certain investors. The complaint alleged violations of Securities Act Sections 5(a), 5(c), 17(a)(2) and (3). To resolve the action each Defendant consented to the entry of a permanent injunction precluding future violations of the Sections cited in the complaint. Mr. Schantz also agreed to be enjoined from selling any promissory notes. In addition, Defendants agreed to pay disgorgement of $3,433,666 along with prejudgment interest and a penalty of $600,000.
Financial fraud: In the Matter of MagaChip Semiconductor Corporation, Adm. Proc. File No. 3-17956 (May 1, 2017). MagaChip manufactures and sells semiconductor products. Its shares have been listed on the NYSE since its IPO in March 2011. Respondent Margaret Hye-Ryoung Sakai, a CPA, was a senior vice president, finance at the firm. Following the firm’s IPO senior executives in Korea placed “immense pressure” on employees to meet the revenue and gross margin targets of the firm. A series of improper accounting practices followed. First, the company engaged in what was known as “pull-in” sales. Under this practice distributors were given undisclosed concessions through side agreements to incentivize them to order products earlier than necessary. Recognition of the revenue from these arrangements was thus contrary to GAAP. Second, MagaChip improperly recognized revenue on what were called “sun ip go” sales, a Korean term. This practice involved the recognition of revenue on sales of non-existent or unfinished product to meet targets. Third, the firm used a variety of other techniques that resulted in the improper recognition of revenue such as improperly accelerating the recognition of $1.8 million of revenue into 2011 by altering a purchase order. Fourth, the firm attempted to conceal rising accounts receivable by applying payments on more recent sales to older ones and making it appear as if the company collected about $16 million of uncollected receivables when it fact it had not. Finally, MagnaChip at times engaged in efforts to manipulate its gross margins. As a result of these improper practices MagnaChip’s financial statements were materially false and misleading every quarter for almost two years. Eventually these practices were discovered through an internal investigation that resulted in a restatement. The Order alleges violations of Securities Act Section 17(a) and Exchange Act Sections 10(b), 13(a), 13(b)(2)(A), 13(b)(2)(B) and 13(b)(5). To resolve the proceeding the firm agreed to implement a series of undertakings. Each Respondent consented to the entry of a cease and desist order based on the Sections cited in the Order, except the order as to the firm did not include Exchange Act Section 13(b)(5). The firm will also pay a penalty of $3 million. A larger penalty was not imposed based on cooperation. A failure to continue to cooperate, comply with its undertakings or if the Division obtains information indicating that the firm knowingly provide materially false or misleading information may result in the imposition of an additional penalty of up to $3 million. Respondent Sakai will pay a penalty of $135,000. She is also denied the privilege of appearing and practicing before the Commission as an accountant and is barred from serving as an officer or director of a public company.
Failure to supervise: In the Matter of Barclays Capital, Inc., Adm. Proc. File No. 3-17953 (May 1, 2017). The Order charges the registered broker-dealer, a subsidiary of Barclays PLC, with failing to supervise two traders. Specifically, the Order alleges that David Wong and Yoon Seok Lee, both employed on the RMB trading desk during the period of June 2009 through December 2012, made misrepresentations in connection with the sale of the securities and charged undisclosed mark-ups. Barclays had the means to monitor communications for false or misleading statements but failed to detect the statements here. The firm maintained a compliance system that was designed to detect transactions with mark-ups above a certain level but it was defective. As a result the firm failed to detect the excessive mark-ups here. Barclays implemented certain remedial acts, cooperated and agreed to a number of undertakings in connection with the settlement which include the reimbursement of customers. The Order alleges that the firm failed to reasonably supervise within the meaning of Exchange Act Section 15(b)(4)(E). The Commission censured Barclays and directed the payment of disgorgement in the amount of $2,930,829, prejudgment interest for the transactions involving false or misleading statements and disgorgement of $6,672,673 along with prejudgment interest for the transactions involving excessive mark-ups. Those amounts will be deemed satisfied by compliance with the undertakings requiring the repayment of customers. The firm will also pay a penalty of $1 million. See also In the Matter of David F. Wong, Adm. Proc. File No. 3-17955 (May 1, 2017)(alleging Mr. Wong made misstatements in connection with the sale of RMBS and excessive mark-ups; resolved with a consent to a cease and desist order based on Exchange Act Section 10(b) and an order suspending Respondent from the securities business and prohibiting him serving as an employee, officer, director or member of an advisory board in the securities business; both suspensions are for a period of twelve months; a penalty of $125,000 was also imposed); In the Matter of Yoon Seok Lee, Adm. Proc. File No. 3-17955 (May 1, 2017)(same except the penalty was $200,000).
Offering fraud: SEC v. Vacchi, Civil Action No. 3:17-cv-00155 (D. Conn.) is a previously filed action against Mark Varacchi and his controlled entity, Sentinel Growth Fund Management, LLC. Sentinel managed two funds. Beginning in late 2015, and continuing for about one year, Defendants raised about $3.95 million for the two funds from investors. The funds were to be allocated to up-and-coming hedge fund managers for investment purposes. In fact the funds were diverted to the personal use of the defendants. 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). This week defendants Sentinel, Mr. Varacchi and relief defendants Radar Alternative Fund LP and Radar Alternative Master Fund SPC consented to the entry of final judgments. Sentinel and Mr. Varacchi are enjoined from future violations of Exchange Act Section 10(b), Securities Act Section 17(a) and Advisers Act Sections 206(1), 206(2) and 206(4). The question of monetary penalties will be considered at a later date. A receiver was also appointed. See Lit. Rel. No. 23822 (May 1, 2017).
Use of fund assets: In the Matter of William Blair & Co. LLC, Adm. Proc. File No. 3-17960 (May 1, 2017) is an action against the registered broker-dealer for erroneously using mutual fund assets to pay for distributions and the marketing of fund shares outside of a written board-approved Rule 12b-1 plan and sub-transfer agent service in excess of those approved. The payments totaled about $1.25 million and resulted in the related disclosures being inaccurate. The firm also failed to disclose to the board of trustees that it would retain a fee for providing shareholder administration services to the funds. The Order alleges violations of Advisers Act Section 206(2). The firm implemented certain remedial acts. To resolve the matter the broker-dealer consented to the entry of a cease and desist order based on the Section cited in the Order and agreed to pay a $4.5 million penalty.
Unregistered securities: SEC v. Lin, Civil Action No. 17 Civ. 3054 (S.D.N.Y. Filed April 26, 2017) is an action which names as defendants Wensheng Lin and Sheng Li Chen, both residents of China. The complaint alleges that the two defendants acquired about 8.4 million shares of Immage Bioherapeutics Corp. at $0.0037 per share (total of about $37,000) and resold them in the market following the issuance of a press release by the company for as much as $1.4745 per share, netting about $1.8 million. The shares were not registered. The Commission suspended trading in the shares of the company. The complaint alleges violations of Securities Act Sections 5(a) and 5(c). The Court entered a freeze order at the time of filing. See Lit. Rel. No. 23821 (May 1, 2017).
EB-5 Offering fraud: SEC v. Serofim Muroff, Civil Action No. 1:17-cv-00180 (D. Idaho Filed April 28, 2017) names as defendants Serofim Muroff, Blackhawk Manager, LLC, ISR Capital, LLC, Equity Recap Account, LLC and Debra L. Riddle. Mr. Muroff is the CEO of Blackhawk and the Idaho State Regional Center and a principal of ISR and Equity Recap; Ms. Riddle is the CFO of ISR and an assistant to Mr. Murdoff; the entity defendants are controlled by Mr. Muroff. From May 2010 through 2013 defendants Muroff, Blackhawk and ISR raised about $140.5 million from over 280 foreign investors through the sale of securities in Blackhawk Gold LLC and Quartzburg Gold, LP. The offerings were sponsored by the Idaho State Regional Center under the EB-5 program which promises a path to citizenship for foreign nationals who make certain investments in the U.S. that create a designated number of jobs. Rather than investing the funds as promised, much of the money was diverted to the personal use of Mr. Muroff. The complaint alleges violations of Exchange Act Section 10(b), Securities Act Sections 17(a)(1) and (3) and Advisers Act Sections 206(1), 206(2) and 206(4). To resolve the action Mr. Muroff and his firms agreed to pay disgorgement of $5,062,082 along with prejudgment interest and a penalty of $2 million. Mr. Muroff also agreed to be prohibited from conducting EB-5 offerings, acting as an officer or director of a public company or associating with any investment adviser. Ms. Riddle agreed to pay disgorgement of $503,417 along with prejudgment interest and a penalty of $100,000.
Financial fraud: In the Matter of David Pruitt, CPA, Adm. Proc. File No. 3-17950 (April 28, 2017); In the Matter of Mark Wentlent, Adm. Proc. File No. 3-17949 (April 28, 2017). These proceedings arise out of a financial fraud at L3 Technologies, Inc. centered on the improper recognition of $17.9 million in revenue at its Army Sustainment Division in 2013 and the first quarter of 2014 which was the subject of a prior Commission enforcement action. Mr. Pruitt was the vice president of finance at the Division. He ordered a subordinate to create 69 invoices related to unresolved claims under a contract referred to as the C-12 Contract in the firm’s internal accounting system and to withhold delivery of the invoices from the U.S. Army. Most of the invoices were never submitted to the Army but were discovered during an investigation. The invoices were entered, resulting in the improper recognition of about $17.9 million. Mr. Wentlend was the President of ASD. He disregarded certain red flags that should have put him on notice regarding the improper revenue recognition. The Order as to Mr. Pruitt alleges violations of Exchange Act Sections 13(b)(2)(A) and 13(b)(5). It will be set for hearing. The Order as to Mr. Wentlend alleges violations of Exchange Act Section 13(b)(2)(A). To resolve the proceeding he consented to the entry of a cease and desist order based on the Section. He will also pay a penalty of $25,000.
Manipulation: U.S. v. Petrossi (E.D.N.Y. Verdict May 2, 2017). Defendant Louis Petrossi, a former registered representative at a brokerage firm, was found guilty by a jury following a two week trial. Mr. Petrossi was charged with participating in a $131 million fraudulent promotion and market manipulation scheme involving ForceField Energy Inc. Mr. Petrossi used a company called Wealth Research Institute to induce investors to purchase shares of ForceField in return for a secret 10% commission. He also engaged in manipulative trading. Mr. Petrossi was convicted of conspiracy to commit securities fraud, conspiracy to commit wire fraud, money laundering conspiracy and securities fraud. He is the ninth person convicted in this scheme. The date for sentencing has not been set.
Insider trading: The Australian Securities Investment Commission announced that Steven Noske has been sentenced to serve 18 months in prison and fined $20,000 for insider trading. The Court, however, ordered his release after nine months on recognizance of $10,000 subject to good behavior for the balance of the term. He is also disqualified from managing corporations for five years. The charge was based on the fact that Mr. Noske, while being consulted by the Managing Director of LNG Limited on its proposed takeover of WestSide Corporation traded in the shares of the target, reaping profits of $51,246.34.
Remarks: Julia Leung, Executive Director, Intermediaries, delivered remarks titled Supervision in a Time of Change, Hong Kong Securities and Investment Institute’s Senior Leaders Programme, May 4, 2017. Her remarks focused on the regulator’s new approach based on front-loaded, targeted, real time actions (here).
Anti-corruption: The Serious Frauds Office charged F. H. Bertling Ltd, a UK subsidiary of Bertling Group, and Robert McNally, Georgia Ayres, Giuseppe Morreaand and Stephen Emler with conspiracy to give or accept corrupt payments in January 2010 and May 2013. The payments were to facilitate the award or retention of contracts for the firm related to the supply of freight forwarding services for the North Sea oil exploration project, Jasmire. Christopher Lane was charged with a separate count of conspiracy to give corrupt payments.
Anti-corruption: The SFO has opened an investigation into the activities of KBR, Inc.’s U.K. subsidiaries for suspected offenses of bribery and corruption. The investigation is related to the SFO’s inquiry into the activities of Unaoil which is alleged to have involved an array of firms including FMC Technologies, Samsung, Hyundai, Rolls-Royce and others.
Remarks: Christopher Wooland, Ex. Director of Strategy and Competition, Financial Conduct Authority, delivered remarks titled The FCA’s Regional FinTech Engagement at the Leeds Digital Festival, FinTech North, Leeds (April 26, 2017). His remarks focused on evolving the regulator’s approach under Project Innovate and its new phase under which regional FinTech hubs emerged (here).
Articles of Note
Steinberg & Roberts, Laxity at the Gates: The SEC’s Neglect to Enforce Control Person Liability, 11 Virginia Law & Bus. Rev. 201 (2017).
Steinberg & Ramirez, The SEC’s Neglected Weapon: A Proposed Amendment to Section 17(a)(3) and The Application of Negligent Insider Trading, 19 Univ. Penn. J. Bus. L. 239 (2017).