A look forward; a look back:
This week the Commission proposed additional rules to simplify and expedite procedures. This time the focus is on Investment Companies and certain procedures regarding exemptions. The agency also invited exchanges and others to comment on trading regarding thinly traded securities.
The Investment Company Act proposal is consistent with earlier efforts to streamline other regulatory requirements initiated by the Commission. The latter is consistent with the main street investor focus of the agency.
Included in the enforcement actions brought recently were two significant cases. One involved crypto currency. While the case focuses on the question of whether the offering at issue should have been registered, it is also a good illustration of the potential cross-currents in regulation potentially involving multiple regulators in this continually emerging area.
The second case involved a massive international market manipulation involving about 3,000 securities, multiple accounts, trades and traders. It is a good illustration of the Commission’s ability to analyze huge batches of data involving transactions over an extended period of time to assess the impact on the U.S. securities markets and participants.
Proposed rules: The Commission proposed amendments to rules that would expedite the review process for applications under the Investment Company Act which are substantially identical to recent precedent as well as those regarding certain internal procedures (Oct. 18, 2019(here).
Thinly traded securities: The Commission issued a statement inviting exchanges and other market participants to submit proposals regarding exchange traded securities that have low volume (Oct. 17, 2019) (here).
SEC Enforcement – Filed and Settled Actions
The Commission filed 5 civil injunctive actions and 1 administrative proceeding last week, exclusive of 12j and tag-along actions.
Lying to auditors: SEC v. Jacoby, Civil Action No. 17-cv-03230 (D. Md.) is a previously filed action in which the Court entered a final judgment by consent against Philip Jacoby, the former chief business officer of a biotech firm, for lying to the firm’s auditors. The Commission’s complaint alleged that for a period almost two years Defendant falsified the firm’s books and records and furnished incorrect information to its outside auditors. The judgment precludes future violations of the provisions of the federal securities laws that prohibit falsifying the books and records and lying to the auditors. See Lit. Rel. No. 24647 (Oct. 17, 2019).
Market manipulation: SEC v. Chen, Civil Action No. 1:19-cv-12127 (D. Mass. Filed Oct. 15, 2019) is an action which named as defendants 18 largely foreign based persons in an international market manipulation case involving about 3,000 securities and over $32 million in trading profits over about four years. As early as 2013 Defendant Jiali Wang, a China resident, began trading in the U.S. markets. Although he had compliance issues at times, Mr. Wang persisted. Eventually he began working in concert with others and opened accounts using other names to conceal his trading. Defendant Xiaosong Wang, a resident of China and Massachusetts, took similar steps. An analysis of IP addresses, computer identifiers and banking transfers demonstrates that Defendants Jiali Wang, Xiaosong Wang, and other individual Defendants, were coordinating their efforts and working in concert. These identifiers link the accounts of fifteen persons to Defendant Jiali Wang. The actual market manipulation scheme, while massive and conducted across international borders, was implemented using traditional manipulation building blocks keyed to actions such as cross trades and wash sales. Over the period Defendants repeatedly manipulated the share price of thousands of securities, typically using the following steps: 1) Orders were placed on an exchange to sell a thinly traded security at prices below the prevailing offer to lower the price; 2) One or more of the accounts intended to profit from the trades would then place buy orders, frequently using a variety of accounts, while the sell orders were still being executed, although the orders seldom crossed; 3) Once the profit or winner accounts had acquired sufficient quantities of the stock, the sell orders were cancelled, and the price would increase to an artificial level; and 4)The profit or winner accounts would then sell their respective holdings, reaping profits based on a manipulated price. During the period a number of the accounts received warnings from the brokerage houses regarding possible wrongful and manipulative trading being conducted in violation of the firm’s policies and procedures. In each instance the trader controlling the account proffered a fabricated excuse. These excuses helped conceal the on-going, years long manipulation. The transmission of proceeds among accounts aided the concealment efforts. The complaint alleges violations of Exchange Act Sections 9(a)(2) and 10(b) and Securities Act Sections 17(a) and (c). The action is pending. The action is paralleled by a case filed by the U.S. Attorney’s Office for the District of Massachusetts.
Crypto assets: SEC v. Telegram Group Inc., Civil Action No. 19 Civ. 9439 (S.D.N.Y. Filed Oct 11, 2019). Defendant Telegram Group Inc. is a privately-owned British Islands firm based in Dubai, UAE. Its primary product is Messenger, a private, encrypted messaging application with about 300 million monthly users, popularly known as the cryptocurrency world’s preferred messenger app. TON Issuers Inc., a named Defendant, is also a BV Islands firm, owned by Telegraph Group. It is based in Tortola. Telegram is owned by Dr. Nikolai Durov and his brother, Pavel. Both are Russian citizens. Pavel resides in Nevis where he is also a citizen. Dr. Durov is the Chief Technology Officer of Telegram. The TON Foundation, controlled by the brothers, is a Cayman Islands non-profit, dedicated to promoting and supporting the TON Blockchain. The Durov brothers launched a version of Telegram Messenger in late 2013. Users of the service were told that it is free and would not sell advertisements. More importantly, users were assured that their privacy would be preserved. The first generation, however, did not have the capability to replace high volume transaction mechanisms like credit cards and fiat currency. By late 2017 the brothers were prepared to launch the next generation of Telegram. It was touted as capable of operating on decentralized applications at a massive scale. The new iteration, called “Telegram Open Network” or “TON,” was designed to host the next-generation of multi-blockchain systems. Telegram described the system as “always [an] expanding and contracting decentralized supercomputer and value transfer system.” Initial investments were solicited to launch. Over a three -month, period beginning in January 2018, Telegram entered into Gram Purchase Agreements with Initial Purchasers. The agreements called for TON Issuer Inc., a subsidiary of Telegram, to issue a new cryptocurrency called “Grams.” A new blockchain platform would be launched known as “TON Network.” Investors purchased Grams for delivery following the completion of the TON Blockchain. After completion of that project, investors would be reimbursed less expenses. The initial offerings were conducted in two phases. Together about 2.9 billion Grams were sold in exchange for $1.7 billion. Over $400 million was raised in the U.S. In the offerings Telegram represented that the Gram Purchase Agreement is an investment contract. The agreement cautioned U.S. based investors that the offer and sale of the security – referencing the Agreement – was not registered under the Securities Act of 1933 and could not be transferred absent an effective registration statement. Grams, however, are not securities, according to Telegram. Grams are a currency. Investors were told that the Grams would appreciate in value over time. This would come not from the ability to exchange them for goods and services which was not existent, but from the build-out of the ecosystem or the TON Network. The series of documents used in connection with the offerings stated that the capital raised from the initial solicitations would be pooled and used over time in connection with the development of the network. Subsequent issuances of Grams would be priced at a premium to those acquired in the initial offerings. Investors had a collective, shared interest in the success of the buildout in view of the potential for the pooled assets to appreciate. The offering materials committed to deliver the Grams and launch the TON Blockchain by no later than October 31, 2019. Defendants are currently preparing for the next offering, needed in part, to fund the continued development of the network as the October 31, 2019 deadline approaches — early costs were privately funded in part by a person in Buffalo, New York. The Commission stated in its complaint that the markets are about to be flooded with unregistered securities which essentially will disappear one issued and sold. The complaint alleges violations of Securities Act Sections 5(a) and 5(c). Earlier this week the Court granted the Commission’s request for a temporary freeze order.
Disclosures: In the Matter of UQM Technologies, Inc., Adm. Proc. File No. 3-19584 (Oct. 11, 2019) is a proceeding which names the manufacturer of motors as a Respondent. In 2015 the firm falsely disclosed that it had secured an agreement with a Chinese firm under which it would obtain about $400 million in revenue. The agreement was supposedly non-cancellable. The firm had not conducted any due diligence on the Chinese company. The claims were false. Nevertheless, they boosted the share price in advance of a planned $6.4 million offering. The Order alleges violations of Securities Act Sections 17(a)(2) and (3) and Exchange Act Sections 13(a). 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 penalty of $500,000.
Unregistered broker: SEC v. Mallion, Civil Action No. 0:19-cv-62532 (S.D. Fla. Filed Oct. 10, 2019) is an action which names as a defendant Richard A. Mallion. Beginning in late 2016, and continuing into the first part of 2017, Defendant solicited investors to purchase shares of Virtual MediClinic USA LLC. He contacted prospective purchasers and informed them that the firm would soon be going public. Investors were also told that they could later sell their shares for $2 or $3 each. Mr. Mallion had no reasonable basis for stating that the shares would trade at those prices. By November 2017 Mr. Mallion was no longer affiliated with the firm. Defendant was also involved with The Luxurious Travel Corp., later known as US Lighting Group, Inc. In connection with this firm he purchased a block of unrestricted shares from a control person which were later sold in part. For the remaining shares he established a call-center which solicited investors and used matched transactions. Defendant was also involved with soliciting investors to acquire shares through subscription. The shares were not registered. Defendant was paid transaction-based compensation. The complaint alleges violations of Securities Act Sections 5(a), 5(c) and 17(a) and Exchange Act Sections 10(b) and 15(a). The case is pending. See Lit. Rel. No. 24642 (Oct. 11, 2019).
Financial fraud: SEC v. White, Civil Action No. 19-civ – 4825 (E.D.N.Y. Filed Aug. 22, 2019); SEC v. Starkweather, Civil Action No. 19-civ-5528 (E.D.N.Y. Filed Sept. 30, 2019). The actions involve two former executives of a penny stock firm. The first action names as defendant William White, the former CEO. The second named as defendants Mr. White and, in addition, Michael Starkweather who also served as CEO for a period. The actions center in part on fraudulent schemes that involved repeatedly arranging for a stock promoter to obtain heavily discounted shares in return for kickbacks on manipulative matched trades from July to November 2016. Defendant Starkweather also issued a false press release supposedly announcing a new smartphone that the firm had developed when in fact the device did not exist. The first complaint alleged violations of Securities Act Sections 17(a)(1) and (3) and Exchange Act Sections 9(a)(1), 10(b) and 20(a). The second alleged violations of Exchange Act Sections 10(b). Each case is pending. The U.S. Attorney’s Office for the Eastern District of New York filed parallel criminal charges. See Lit. Rel No, 24646 (Oct. 17, 2019).
Remarks: James Shipton, Chair, Australia Securities Investment Commission, delivered remarks titled “Other People’s Money” and Changing Global Markets, as the keynote address at the Asia Securities Industry & Financial Markets Association Annual Conference, Tokyo, Japan (Oct. 10, 2019). His remarks focused on themes from the book Other People’s Money by John Jay, stressing that the numbers on the computer screens represent the money earned by investors (here).
Remarks: Loo Siew Yee, Asst Managing Director (Policy, Payments & Financial Crime) delivered remarks titled Combatting Financial Crime Through New Technologies Built on Strong Fundamentals at the International Compliance Association Annual APAC Conference (Oct. 16, 2019)(here). Her remarks focused on anchoring AML/CFT on strong fundamentals keyed to supervision and surveillance, thematic reviews, analytical data reviews and robust supervision of virtual asset service providers.