This Week In Securities Litigation

by Dorsey & Whitney LLP

The Commission issued rules this week regarding changes to its public liquidity risk management disclosure for open ended funds. In addition, proposed rules were issued regarding its whistleblower program and the regulatory framework for ETFs.

A second insider trading case arising out of the Equifax breach was filed this week along with a parallel criminal action. The Commission also brought a sales practice case was against Wells Fargo and a trading practices action centered on failing to comply with Regulation SHO regarding short selling against a broker-dealer.


Rules: The Commission adopted certain changes to its public liquidity risk management disclosure for open ended funds. Specifically, the amendments, which replace certain prior filings made on Form N-PORT, require funds to discuss the operation and effectiveness of their liquidity risk management programs in certain filings (here).

Proposed rules: The Commission proposed amendments to the whistleblower rules. The amendments are designed to give the agency additional tools in making whistleblower awards to ensure that meritorious whistleblowers are appropriately rewarded for their efforts and to increase the efficiency of the program (here).

Proposed rules: The Commission proposed a new rule and form amendments to update the regulatory framework for ETFs. The rule is designed to facilitate greater competition and innovation in the ETF market place, providing investors with more choice (here).

MOU: The Commission and the CFTC announced the approval of a new MOU to facilitate the coordination of the two agencies (here).

SEC Enforcement – Filed and Settled Actions

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

Insider trading: SEC v. Bonthu, (N.D. Ga. Filed June 28, 2018) is an action against Sudhakar Reddy Bonthu, a former employee of Equifax Inc. Prior to the public announcement of the massive data breach at the firm, Defendant was assigned to do certain website work, but was not told it was for the company. Based on the information he was furnished Defendant determined that it was for the firm and that there was a breach. Mr. Bonthu then purchased put options which he sold after the announcement of the breach for a profit of $75,000. The complaint alleges violations of Exchange Act section 10(b). To resolve the action Mr. Bonthu agreed to the entry of a permanent injunction and to pay disgorgement and prejudgment interest. He was also charged in a parallel criminal case. U.S. v. Bonthu, No. 11-cr-00237 (N.D. Ga. Filed June 28, 2018).

Reg SHO: In the Matter of Bayles Capital, LLC, Adm. Proc. File No. 3-18558 (June 28, 2018) is an action which names the registered broker-dealer as a Respondent. Under Reg SHO a broker is required to mark all sell orders for any equity security as long, short or short exempt. The Regulation also prohibits a broker or dealer from accepting a short sale order in an equity security from another person or effecting a short sale in such a security for its own account unless the firm has borrowed the security, entered into an arrangement to borrow it or has reasonable grounds to believe that the security can be borrowed. The broker also has an obligation to have certain compliance procedures. Respondent, over a year long period beginning in August 2016, mis-marked about one million orders in its principal account as sell long instead of sell short, did not comply with the locate requirement prior to executing short sale orders and failed to comply with the circuit breaker requirements designed to prevent the execution or display of a short order sale of a covered security under certain circumstances. The Order alleges violations of rules 200(g)(1) and 203(b)(1) of Regulation SHO. To resolve the proceedings Respondent consented to the entry of a cease and desist order based on the rules cited in the Order as well as a censure. The firm will also pay a penalty of $300,000.

Insider trading: SEC v. Pinto-Thomas, Civil Action No. 1:18-cv-05757 (S.D.N.Y. Filed June 26, 2018) is an action which names as defendants Sebastian Pinto-Thomas, Abell Oujaddou and Jeremy Millul. Mr. Pinto-Thomas is a junior analyst at a major credit rating agency. The other two defendants are his friends. The action centers on the March 20, 2016 announcement that The Sherwin-Williams Company had agreed to acquire The Valspar Corporation. In early March 2016 the credit rating agency where Mr. Pinto-Thomas worked was consulted by The Sherwin-Williams Company concerning the proposed deal. Mr. Pinto-Thomas learned about the proposed transaction and told his two friends. Both traded. Following the deal announcement Mr. Millul had profits of $107,000 while Mr. Oujaddou had profits of about $192,000. The complaint alleges violations of Exchange Act section 10(b). The case is pending.

Offering fraud: SEC v. Weed, Civil Action No. 1:14-cr-10348 (D. Mass.) is a previously filed action against attorney Richard Weed. The complaint alleges that he helped others create a public company using reverse mergers and to sell unregistered shares. Mr. Weed backdated certain documents and falsified others. He has been convicted on parallel criminal charges and sentenced to serve four years in prison. In this case the court previously entered summary judgment against attorney Weed in favor of the Commission. The court has entered a final judgment imposing a permanent injunction prohibiting future violations of Securities Act section 17(a) and Exchange Act section 10(b). Mr. Weed has also been ordered to pay a penalty of $150,000 and barred from serving as an officer or director of a public company. See Lit. Rel. No. 24175 (June 26, 2018).

Offering fraud: SEC v. VanBlaricum, Civil Action No. 4:18-cv-518 (N.D.Tx. Filed June 26, 2018) is an action which names as defendants James VanBlaricum, a securities law recidivist, Rodney Pope, Chet Inglis, Matthew Leaverton, William Hill, Erik Rhodes and Robert Gilliam. Over about a three year period beginning in May 2013 defendants raised over $10 million from hundreds of investors who were solicited to and invested in Texas Energy Mutual, LLC. The offering materials were fraudulent, omitting the fact that Mr. Valbaricum controlled the firm, thereby concealing his background and falsely guaranteed a 10% annual return and full payment of the notes within three years. Portions of the investor funds were misappropriated. The complaint alleges violations of Securities Act sections 5(a), 5(c) and 17(a) and Exchange Act sections 10(b) and 15(a). Defendants VanBlaricum, Pope, Inglis, Gillam, Hill and Rhodes each settled, agreeing to be permanently enjoined from violating the sections cited in the complaint. Mr. Rhodes agreed to pay disgorgement of $33,000 while the court will determine questions regarding disgorgement and penalties with respect to Mr. Hill. Defendants VanBlaricum, Pope, Inglis, Leaverton and Gilliam have been charged in a parallel criminal action and have each pleaded guilty and were sentenced to prison terms ranging from 30-84 months and ordered to pay between $1.8 million and $32 million in restitution. See Lit. Rel. 24176 (June 26, 2018).

Sales practices: In the Matter of Wells Fargo Advisers, LLC, Adm. Proc. File No. 3-18556 (June 25, 2018). Respondent is a registered broker-dealer and investment adviser. The firm is a combination of Wells Fargo Investments LLC and Wachovia Securities. This action is based on a four year period beginning in January 2009 and certain sales practices for complex products. Specifically, the case centers on the sale and redemption of market-linked investments or MLIs, a fixed maturity financial product tied to a reference asset or market measure. MLIs are structured financial products with a fixed maturity. MLIs were not suitable for short-term trading due to their limited liquidity, according to disclosure provided to investors by Respondent. Rather, they represented a buy and hold investment largely because of the fees which are significant. During the period here, certain representatives at Wells Fargo Advisers engaged in a sustained practice of soliciting customers to purchase MLIs, redeem them prior to maturity and purchase new MLIs. In many instances those redemptions occurred within a year despite firm policy to the contrary. This meant that customers incurred substantial costs while Wells Fargo Advisers profited. Representatives who repeatedly solicited customers to use MLIs as short term investments did not conduct the appropriate analysis despite the fact that such a recommendation is based on an implied representation that it has a reasonable basis, according to the Order. Supervisors routinely approved such transactions with little analysis. As a result, Respondent violated Securities Act sections 17(a)(2) and (a)(3). To resolve the proceedings Respondent consented to the entry of a cease and desist order based on the sections cited in the Order. In addition, Respondent will pay disgorgement of $930,377, prejudgment interest of $178,064.27 and a penalty of $4 million.

Lying to auditors: SEC v. Pence, Civil Action No. 15-cv-7077 (S.D.N.Y.) is a previously filed action against Stephen Pence, the former chairman and majority shareholder of General Employment Enterprises. He is also a former U.S. Attorney and lieutenant governor of Kentucky. The Commission’s complaint alleged that he lied to the firm’s auditors, creating the impression that he was acting independently when in fact he was a front for a convicted felon. The court entered a final judgment against Mr. Pence. Defendant had consented to the entry of a permanent injunction based on Exchange Act section 10(b) and rules 10b-5 and 13b-2. He also agreed to pay a civil penalty of $200,000 and to the entry of an officer and director bar. See Lit. Rel. No. 24174 (June 22, 2018).

Criminal Cases

Financial fraud: U.S. v. DiMaria, No. 1:17-cr-20898 (S.D.Fla.) is an action against Edward DiMaria, the former CFO of publically traded Bankrate Inc.. Mr. DiMaria pleaded guilty to one count of conspiracy to make false statements to a public company’s accountants, falsify the firm’s books and commit securities fraud and one count of conspiracy to make false statements to the SEC. Mr. DiMaria admitted that between 2010 and 2014 he engaged in a complex financial fraud to falsify the books of the company by maintaining a cookie jar reserve, improperly classifying certain expenses and lying to the SEC. The scheme caused more than $25 million in losses for shareholders. Previously, another bank official pleaded guilty in connection with the scheme. The date for sentencing has not been set.

Offering fraud: U.S. v. Galanis, No. 1:16-cr-00371 (S.D.N.Y.) is an action in which John Galanis, Devon Archer and Bevan Cooney were each convicted of securities fraud and conspiracy to commit securities fraud following a five and one half week jury trial. The charges were based on a scheme execute from March 2014 through April 2016 in which the three Defendants and others caused the Wakpamni Lake Community Corporation, a Native American tribal entity, to issue $60 million of bonds through misrepresentations, caused asset managers to purchase the illiquid securities and then misappropriated the funds. The date for sentencing has not been set.

Misappropriation: U.S. v. Peterson, No. 1:18-cr-10027 (D. Mass.) is an action in which former investment adviser Cornelius Peterson was sentenced to serve 20 months in prison followed by two years of supervised release and to pay restitution of $462,000. The sentence is based Mr. Peterson’s guilty plea to one count of conspiracy and investment adviser fraud and three counts of bank fraud. The charges were based on a scheme that took place from 2014 through June 2017 in which the Defendant and another misappropriated about $500,000 from their clients by transferring the funds without the knowledge of the clients. See also SEC v. Polese, Civil Action No. 1:18-cv-10186 (D. Mass.).

Investment fraud: U.S. v. Davis, No. 1:18-cr-00025 (N.D. Ill.) is action in which financial adviser Darayl Davis has been charged in a superseding indictment with six counts of money laundering, five counts of wire fraud, four counts of mail fraud and one count of aggravated identity theft. The charges are based on $4.7 million in investor losses allegedly caused by Mr. Davis by inducing his clients to roll over their retirement accounts into investments supposedly backed by well known large insurance companies. In fact Mr. Davis misappropriated the funds. The case is pending.

Investment fraud: U.S. v. Bergstein, No. 1:16-cr-00746 (S.D.N.Y.) is an action in which defendant David Bergstein, a Hollywood film producer, was found guilty by a jury of securities fraud, wire fraud, investment adviser fraud and conspiracy. The charges were based on a scheme Defendant executed from 2011 through 2012 in which he defrauded investors in Weston Capital Asset Management, a registered investment adviser. First, Mr. Bergstein concealed material information about financial transactions involving investor funds. Second, investor funds were transferred from one pool to another without consent. Portions of the investor funds were misappropriated. Mr. Bergstein was sentenced to serve eight years in prison and pay $26 million. The prison term will be followed by three years of supervised release. Forfeiture and restitution amounts will be determined at a later date.

Overcharged commissions: U.S. v. McLellan, No. 1:16-cr-10094 (D. Mass.). Defendant Ross McLellan was found guilty of one count of conspiracy to commit securities fraud and wire fraud, two counts of securities fraud and two counts of wire fraud. The charges stem from a scheme to defraud clients in the bank’s transition management business, conducted for institutional clients transitioning or liquidating a portfolio, according to papers in the criminal and parallel SEC civil action. From early 2010, through the fall of 2011, State Street offered transition services to customers in the U.S. and elsewhere. In 2010 State Street began to experience a shortage of major transition management deals. That impacted the financial performance of the business segment. From February 2010 through September 2011 Mr. McLellan, along with others, charged hidden mark-ups to transition management customers to generate additional revenue. Mr. McLellan also gave specific instructions to keep the additional charges hidden. During the period additional charges were added to the transition for six different clients. The jury deliberated five hours before returning verdicts of guilty on five of six counts. Previously, two State Street employees pleaded guilty to participating in the scheme. See also SEC v. McLellan, Civil Action No. 1:16-cv-10874 (D. Mass. Filed May 13, 2016). The U.K.’s Financial Conduct Authority found that State Street deliberately overcharged six customers $20,169,602 and imposed a financial penalty of £22,885,000.


Report: The Australian Securities and Investments Commission published a report on proxy adviser engagement practices. The report covers conduct observed and suggests practices for firms and proxy advisers to improve their engagement (here).

Hong Kong

Financial fraud: The Securities and Futures Commission initiated proceedings in the Market Misconduct Tribunal against Li Kwok Cheong and Li Han Chun, former chairman and CEO of China Forestry Holdings Company Ltd, respectively. The proceedings are based on the suspected disclosure of false or misleading financial information in the firm’s IPO prospectus, annual reports and other documents. The falsifications tie to a number of different accounts. The firm kept two sets of books and withheld the proper information from KPMG, its auditors.

False statement: DBA Telecommunications (Asia) Holdings Ltd. pleaded guilty to making a false or misleading statement in an SFC proceeding. The plea was based on the fact that the firm published its financial results on the Stock Exchange of Hong Kong website, stating that they had been compiled in accord with the applicable requirements. In fact the statements had not been approved by the auditors. The firm was fined $20,000.

Report: The SFC published its annual report. The report summarizes and provides key statistics regarding the deal. It also highlights efforts undertaken to promote healthy and sustained markets (here).


Manipulation: The Securities and Exchange Surveillance Commission recommended to the Prime Minister and the Commissioner of the Financial Services Agency that an penalty of 4,930,000 yen (about U.S. $44,800) be imposed on a China based resident who manipulated the share price of Cocokara Fine Inc. on the Tokyo Stock Exchange. The manipulative trades were conducted on July 8 and July 14, 2015. In each instance the trader placed either large purchase orders but ultimately executed only a small portion of them or placed large sell orders but only executed a small portion to feign market activity.


Corruption: The Securities Frauds Office announced that it had commenced criminal proceedings against Unaoil Monaco SAM and Unaoil Ltd. as part of an ongoing corruption prosecution. The charges follow those brought against four individuals for alleged conspiracy to make corrupt payments to secure the award of contracts in Iraq.

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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