The SEC filed two civil injunctive actions this week. Once focused on an investment fraud scheme in which interests were sold in what was falsely claimed to be a motion picture production which would have A list celebrities. The other centered on a fraudulent options trading scheme.
The Commission prevailed in a Third Circuit appeal from a judgment entered in its favor in an enforcement action centered on fraud and Section 13(d) claims. In a 2-1 decision the Court sustained the Commission’s position on the calculation of disgorgement where there was a claimed intervening cause.
Finally, a report on recent filings in securities class actions notes that while the number of cases filed last year increased compared to the prior year, the number is still below historical averages for recent years. The report also notes that most recently filed securities class actions are based on Exchange Act Section 10(b) and focus on financial fraud claims.
Adviser inspections: The Commission announced that OCIE is launching an initiative regarding the inspection of advisers who have registered but never been inspected (here).
Whistleblowers: An amicus brief was filed in the Second Circuit Court of Appeals by the Commission in support of a whistleblower (here).
Securities class actions
Statistics: A new report from Cornerstone Research tiled Securities Class Action Filings, 2013 Year in Review (here) shows that last year the number of securities class actions filed ticked-up slightly to 166 compared to 152 in the prior year. That number is, however, the lowest since 2006 and, excluding that year, represents the fewest number of actions initiated since 1997. The Report also shows that over the years the legal basis for the actions has narrowed, focusing on Rule 10b-5 claims. In 2013 84% of the cases brought asserted a claim under this Rule. That is about the same as in 2012 but up substantially from 2011 at 71%, 2010 at 66% and 2009 at 69%. Similarly, claims asserted in class action filings are increasingly focusing on allegations of misrepresentations in financial documents. In 2013 97% of the cases were based on this claim compared to 89% in 2009.
Two additional findings in the Report center on the number of companies listed on U.S. exchanges and IPO and M&A activity. As to the former, the number has declined 46% since 1998. However, the rate of decline has slowed to 3% from the 6% that had prevailed in earlier years. As to the latter, a comparison of IPO and M&A activity reflects a decline in the number of initial public offerings compared to mergers in recent years. From 1990 through 1997 IPOs equaled or outnumbered M&A deals in six of eight years. That trend reversed during the period 1998 through 2013 when M&A deals outnumbered IPOs in every year.
SEC Enforcement – Filed and Settled Actions
Statistics: This week the Commission filed or announced the filing of 2 civil injunctive, DPAs, NPAs or reports and no administrative proceedings (excluding follow-on and Section 12(j) proceedings).
Investment fund fraud: SEC v. Braslau, Civil Action No. 2:14-cv-01290 (C.D. Cal. Filed Feb. 20, 2014) is an action against Samuel Braslau, Rand Chortkoff and Stuart Rawitt. The case centers around a fraudulent scheme overseen by Mr. Braslau that involved his two entities, Mutual Entertainment, LLC and its successor, Film Shoot, LLC. The entities sold securities purportedly for the purpose of financing a feature film to be made with A list actors. Beginning in April 2011, and continuing until mid-2013, Mr. Brashau and his entities raised about $1.8 million from more than 60 investors. The funds were raised through a boiler room operated by Rand Chortkoff. A series of sales people, including securities law recidivist Stuart Rawitt, sold investors interests in the claimed venture. In fact much of the money was diverted to the defendants and their cohorts. The complaint alleges violations of Securities Act Section 17(a) and Exchange Act Sections 10(b), 15(a) and 15(b)(6)(B)(1). The case is in litigation.
Investment fraud: SEC v. Williams, Civil Action No. 3:12 cv 01068 (D. Conn.) is a previously filed action against Jerry Williams and his two companies, Monk’s Den, LLC and First In Awareness, LLC. Mr. Williams solicited potential investment clients through his web site, Monk’s Den, and in seminars. He told them he had a “Float Lock Down” strategy through which they could make large profits. To effectuate the strategy clients were directed to buy shares of two companies. The point was to reduce the float and cause a short squeeze. What Mr. Williams did not tell clients is that the two companies paid him in shares to promote their stock. While his clients purchased shares Mr. Williams sold, netting him over $2.3 million in profits. This week the Court entered judgment against the three defendants based on consent. The order enjoined them from future violations of Exchange Act Section 10(b), Securities Act Sections 17(a) and (b) and Advisers Act Sections 206(1) and 206(2). The defendants are also jointly and severally liable for the payment of $2,357,208 in disgorgement, prejudgment interest and a civil penalty of $2,357,208. A penny stock bar was imposed on Mr. Williams. See Lit. Rel. No. 22928 (Feb. 19, 2014).
Fraudulent trading scheme: SEC v. Lee, Civil Action No. 14CV0347 (S.D. Cal. Filed Feb. 13, 2014). James Lee is an unregistered investment adviser. Beginning in late 2008 he solicited investors in California, Colorado, Texas and other states to open online brokerage and margin accounts. The accounts were discretionary, giving him the authority to trade in options. Overall he raised about $25 million from investors.
Mr. Lee assured investors that he was a seasoned trader with substantial experience and advanced degrees, that he had a proprietary trading program, that he would split their loses with them in return for half of their profits and that his program had a stop lose mechanism to protect them. What Mr. Lee failed to tell investors was that he had previously been convicted of fraud, had a Commission cease and desist order entered against him by default, the risks of trading naked options and that he also traded penny stocks without their authority. His claims regarding splitting all losses and a stop loss were false, according to the complaint. By early 2012 he had lost over $11 million of investor funds. By that point Mr. Lee had been paid about $3.3 million in fees. The Commission’s complaint alleges violations of Exchange Act Section 10(b), Securities Act Sections 17(a)(1) and (2) and Advisers Act Sections 206(1) and (2). The case is in litigation. See Lit. Rel. No. 227927 (Feb. 14, 2014).
Disgorgement: SEC v. Teo, Case No. 12, 1168 (3rd Cir. Decided Feb. 10, 2014) centered on the question of disgorgement and intervening causes. Appellant Alfred Teo is an investor who established the MAAA Trust of which he is the beneficial owner. In February 1997 28 brokerage accounts controlled by Mr. Teo, including those in the name of the Trust, held about 5.25% of the outstanding shares of Musicland. That firm had a
“poison pill” that would be triggered when an individual or group acquired 17.5% of the firm’s shares. On July 30, 1998 Mr. Teo filed Amendment 7 to his Schedule 13D disclosures. It stated that Mr. Teo no longer had investment power with respect to the trust. Subsequently, Mr. Teo consistently reported that his ownership percentage in Musicland remained below the 17.5% threshold, although he continued to acquire shares.
By August 2, 1998, together with the trust, Mr. Teo controlled 17.79% of the shares while by early December 2000 that percentage had increased to 35.97%, according to the findings of the District Court. Throughout the period Mr. Teo sought to join the Musicland board and take the company private. Mr. Teo did not file Schedule 13D disclosures on any of these activities. In December 2000 Best Buy Co. announced an all cash tender offer for all of the shares of Musicland. The stock price rose following the announcement. The firm acquired the Musicland shares in January 2001.
In April 2004 the SEC filed an enforcement action against Mr. Teo alleging violations of Exchange Act Sections 13(d) and 10(b). A jury found after trial that Mr. Teo violated both Sections while the trust had contravened Section 13(d). The District Court directed the payment of $17,422,054.13 in disgorgement along with prejudgment interest.
The Circuit Court affirmed. The Court rejected Appellants’ claim that it was error to order as disgorgement the profits that resulted from the Best Buy tender offer. The SEC need only establish a but for causal link between the violation and the amount of the disgorgement the Court held. This is because the use of disgorgement as a remedy by the agency is intended to deprive the wrongdoer of his unjust profits and deter other violations. Thus the Commission need only establish a reasonable approximation of the illegal profits that flow on a but for basis from the violations, not proximate cause as in a private damage action. Any question about an intervening cause must be raised by the defendant the Circuit Court concluded.
Here the SEC documented the purchases, the percentage of ownership, the false reporting and the profits that flowed from the violations. This established the presumptive profits. Appellants did virtually nothing to rebut the presumption established by the agency. Accordingly, the Court rejected the contention that the Best Buy tender offer was too far removed in time from the violations. Rather, the type of conduct here is the focus of the Exchange Act and Sections 10(b) and 13(d).
Circuit Judge Jordan dissented in part. Judge Jordan agreed that the proximate cause test used in private actions does not apply and that the but for test is appropriate in an SEC enforcement action. He also agreed that the burden shifting approach as to intermediate causes adopted by the majority is reasonable and that the SEC had met its initial burden.
The Appellants, however, pointed to the Best Buy tender offer as an independent cause. “Neither the District Court nor the Majority appropriately accounts for the Best Buy tender offer . . . [rather ] the majority pays lip service to the limiting principle that, to avoid being a punitive measure, a disgorgement order must be limited to ill-gotten gains . . .”
In this case “[t]he Best Buy tender offer is clearly an independent and intervening event. It bears no relationship to the Appellants’ securities violations.” Once the Appellants presented but for evidence of an intervening cause, it was the burden of the SEC to establish its claim. That was not done here.
Whistleblowers: The Australian Securities and Investment Commission announced new protections for whistleblowers (here).
Libor: The Serious Fraud Office commenced criminal charges against three former employees at Barclays Bank Plc. Peter Charles Johnson, Jonathan James Mathew and Stylianos Contogoulas were charged in connection with the manipulation of LIBOR. The investigation is on-going.
Deferred prosecution agreements: The SFO published new guidance on the use of Deferred Prosecution Agreements. Those agreements will become available on February 24, 2014.
Investment fund fraud: The Financial Conduct Authority announced that Benjamin Wilson had been sentenced to serve seven years in prison following his guilty plea on fraud charges. Mr. Wilson had run investment firm SureInvestment. It raised about £21 million from over 300 investors. In fact the firm was a sham. The FCA estimates that about £5.39 million will be recovered.
For more commentary on developing securities issues, visit SEC Actions, a blog by Thomas Gorman.
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