The critical question moving forward for the SEC is the ruling in Liu v. SEC, a case heard by the Supreme Court this week. Potentially the ruling will determine if the Commission can seek disgorgement in civil injunctive actions and, if so, how will it be defined.
Frequently, the Justices ask probing questions on different issues at oral argument. The Liu hearing was no different in that respect. What was different is the apparent consensus. Throughout the arguments the Justices seemed to implicitly agree that disgorgement can be obtained by the agency.
If that is correct – and assessing what an opinion might say based on oral argument is always hazardous – the question will be the definition. Specifically, the point may well be whether disgorgement should be limited to its traditional, equitable roots. In that instance the focus may be on returning improperly obtained sums to the person or persons harmed – not the U.S. treasury as so frequently is the case today. If disgorgement is defined in this fashion recoveries in SEC enforcement actions may, in many instances, be curtailed. There may also be cases in which it is not available. A ruling in Liu is due by June 30, 2020.
The Commission turned its attention this week to the virus which has spooked financial markets in recent weeks, offering relief for issuers with certain deadlines. The agency also continued its drive to simplify certain provisions relating to raising capital.
The focus of Enforcement, in contrast, remained unaltered — retail investors. Two actions were brought against persons acting as unregistered brokers. A third centered on FCPA violations.
Proposed rules: Proposed rule changes designed to harmonize and simplify the exempt offering framework were published on March 4, 2020. Specifically, the proposals are designed to address gaps and complexities in the exempt offering framework that may impede access to investment opportunities (here).
Relief: The Commission authorized conditional regulatory relief and assistance for issuers impacted by the Coronavirus Disease on March 4, 2020. The Order centers on meeting certain filing deadlines which might be impacted (here).
Amended rules: Amendments regarding debt offerings designed to remove unnecessary impediments to such offerings were published on March 2, 2020 (here).
Amended exemptions: The agency adopted amendments to the provisions governing the registration for advisers to rural business investment companies on March 2, 2020. The amendments are designed to facilitate the process (here).
SEC Enforcement – Filed and Settled Actions
The Commission filed 2 civil injunctive actions and 1 administrative proceeding last week, exclusive of 12j and tag-along actions, discussed below.
Unregistered broker; SEC v. Brook Church-Koegel, Civil Action No. 24759 (S.D.Fla. Filed March 5, 2020) is an action which names as defendants Brook Church-Koegel, David H. Goldman and Nicole Walker. Over a three-year period, beginning in June 2014, Defendants sold shares of the Woodbridge Group of Companies. Approximately $444 million was raised from investors. The firm and its then president were operating a Ponzi scheme. The three Defendants were paid at least $2.75 million in transaction-based compensation for their work. The complaint alleges violations of Securities Act Sections 5(a) and 5(c) and Exchange Act Section 15(a)(1). The action is pending. See Lit. Rel. No. 24759 (March 5, 2020).
Fraudulent trading scheme: SEC v. Fowler, Civil Action No. 00139 (S.D.N.Y.) is a previously filed action which names as a defendant Donald J. Fowler, formerly a registered representative. Earlier, a jury concluded that Mr. Fowler had defrauded his clients by engaging in a trading scheme that was unsuitable for them but resulted in large commissions for him. The Court entered a final judgment against Mr. Fowler, prohibiting future violations of Securities Act Section 17(a) and Exchange Act Section 10(b). The order also directs Defendant to pay disgorgement in the amount of $132,085, prejudgment interest of $35,195.04 and a penalty of $1,950,000. Previously, the Commission obtained a final judgement against Mr. Fowler’s partner in the scheme. See Lit. Rel. No. 24756 (March 2, 2020).
Offering fraud: SEC v. Burkholz, Civil Action No. 19 Civ. 24713 (S.D. Fla.) is a previously filed action centered on a Ponzi scheme. This week the Court entered final judgments against two firms that participated in the fraud, Palm Financial Management, LLC and Shore Management Systems LLC. Those judgments prohibit future violations of Exchange Act Section 10(b). In addition, they direct the payment of disgorgement in the amount of $624,121 and $599,645, respectively. The Commission will seek approval to establish a fair fund. See Lit. Rel. No. 24755 (March 2, 2020).
False statements: SEC v. Ustian, Civil Action No. 16-cv-3885 (N.D. Ill.) is a previously filed action which named as a defendant Daniel C. Ustain, the former CEO of Navistar International Corporation. The complaint alleged that Mr. Ustain mislead investors regarding the development of an advanced technology truck engine that could satisfy U.S. pollution standards. The action was previously settled. The Court entered a final judgment as to Mr. Ustain, prohibiting future violations of Securities Act Section 17(a) and Exchange Act Sections 10(b) and 13(a). The judgment also directs that Mr. Ustain pay a penalty in the amount of $250,000 and disgorgement in the same amount. See Lit. Rel. No. 24753 (March 2, 2020).
Unregistered broker- microcap fraud: SEC v. Bongiorno, Civil Action No. 1:20-cv-00469 (N.D. Ohio Filed Feb. 28, 2020). This action centers on the sale of shares in two microcap firms by Defendants Christopher Bongiorno and Jason Arthur. Over a period of several years ending in 2019 the two men received over $2.5 million in commissions for selling shares of the two issuers despite not being properly registered with the Commission. The sales began in September 2015 and continued until early 2019. In each instance investors were solicited by Defendants using fictitious names and asserting claims regarding the issuers. Defendants, who told some investors they were paid a salary, in fact received about 40 to 50% of the investor funds received. They also misappropriated a portion of the funds. The complaint alleges violations of Exchange Act Sections 10(b) and 15(a)(1) and Securities Act Section 17(a). The case is pending. See Lit. Rel. No. 24754 (March 2, 2020).
In the Matter of Cardinal Health Inc., Adm. File No. 3-19718 (Feb. 28, 2020). Cardinal Health is a global, integrated healthcare services and product firm based in Ohio. It specializes in the distribution of pharmaceuticals and other medical products. After entering the Chinese market in late 2010 the firm acquired Chinese subsidiaries – Cardinal China. Those firms had longstanding distribution agreements with certain global manufactures of prescription medications, medical devices and consumer health products.
Over a six-year period, beginning in 2010, the subsidiary acted as the exclusive distributor in the Chinese market for a large European dermo cosmetic company. Cardinal Health assessed the risk of the arrangements as minimal. Accordingly, it did not subject the firm to its full internal controls, including those regarding the FCPA. Cardinal China thus executed payments requested by the marketing employees without requiring sufficient supporting documents regarding the purpose of the transactions. Over a four-year period from 2013 to 2016 the firm authorized and paid over $250 million from the marketing accounts. A number of these payments were improperly redirected to government employed healthcare providers of Chinese state owned retailers to promote product. By 2016 Cardinal China had directly profited, and Cardinal Health had been unjustly enriched, by about $5.4 million. The Order alleges violations of Exchange Act Sections 13(b)(2)(A) and 13(b)(2)(B).
To resolve the proceedings the firm consented to the entry of a cease and desist order based on the sections cited in the Order. In addition, Cardinal Health agreed to pay disgorgement in the amount of $5.4 million along with prejudgment interest of $916,887. The firm will also pay a penalty in the amount of $2.5 million. The Commission considered the fact that Cardinal Health self-reported, cooperated and engaged in remedial actions.