SEC Enforcement Actions Decline in 2020
According to the annual report published by the Division of Enforcement of the U.S. Securities and Exchange Commission (the “SEC”), there were 715 overall enforcement actions in fiscal 2020, down 17% from the previous year.
Despite the slow down, financial remedies ordered “set a new high,” according to Stephanie Avakian, the agency’s enforcement chief. The Commission obtained judgments and orders totaling approximately $4.68 billion in disgorgement and penalties – the highest amount on record.
Similarly, Avakian said, “the number and amount of whistleblower awards exceeded prior years — in fact, awards issued in 2020 accounted for roughly 37% of the total number of individuals awarded over the entire life of the whistleblower program.”
Caveat Emptor Securities Hit with a Big Setback
Last week, E*TRADE, a subsidiary of Morgan Stanley, which offers an electronic trading platform to trade financial assets including common stocks, announced that effective November 21, 2020, customers will no longer be able to open positions in Caveat Emptor securities due to the risks associated with trading shares in these companies.
E*TRADE further stated that Caveat Emptor securities currently held in accounts will be set to liquidation only, meaning you may close or continue to hold existing positions but no new or additional positions may be added. E*TRADE will also prohibit deposits and transfers in Caveat Emptor securities as of the effective date. The full statement can be found on the E*TRADE website.
SEC Awards Two Unique Whistleblower Awards
On November 13, 2020, the Securities and Exchange Commission (the “SEC”) announced an award of over $1.1 million to a whistleblower whose independent analysis led the staff to look at new conduct during an ongoing investigation.
The award is notable because it was a unique case where the receipt wasn’t a person, directly connected to the organization or individual that committed the fraud, sharing insider information, an encouraging sign for diligent shareholders or internet sleuths putting in the time to research and report potential fraudulent behavior.
According to the SEC press release, this whistleblower examined publicly available materials and conducted an analysis that revealed important new insights into the securities law violations, which helped the SEC protect investor assets from dissipation by the wrongdoer. The whistleblower’s information and exemplary assistance helped the agency bring an emergency action preventing further investor harm.
SEC Amends Regulation A, Crowdfunding and Rule 504 Securities Exemptions
On November 2, 2020, the Securities and Exchange Commission (the “SEC”) adopted amendments to the rules for exempt offerings under the Securities Act of 1933, as amended (Securities Act). Among other changes, the amendments (collectively the “Amendments”): (1) establish a new integration framework for issuers to move from one securities offering exemption to another; (2) increase the current offering and investment limits for Regulation A Offerings, Regulation Crowdfunding – Regulation CF and Rule 504 offerings; and (3) amend “Test-the-Waters” and “Demo Day” offering communications rules. The Regulation A and Rule 504 Amendments will become effective 60 days after publication in the Federal Register, and the Regulation Crowdfunding amendments will be effective upon publication in the Federal Register. Read More
Do Blue Sky Laws Apply to Regulation A Resales and Secondary Trading?
A sometimes overlooked aspect of Regulation A+ is the impact of state blue sky laws on liquidity and resales also known as secondary sales. State blue sky laws are applicable to resales by purchasers in Regulation A Offerings and vary from state to state. From a practical perspective, a company raising capital should consider liquidity for investors and the rules that apply to secondary trading.
The trading of securities of issuers listed on National Securities Exchanges like the NASDAQ Stock Market and the New York Stock Exchange (“NYSE”) are exempt from State blue sky laws that govern secondary trading; however, companies on the OTC Markets must comply with state blue sky laws for both their Regulation A+ offering and resales by the purchasers in the offering.
Tier 1 v Tier 2 – Regulation A State Blue Sky Compliance
Regulation A+ includes two offering tiers, each with different characteristics and requirements. Each Regulation A+ tier is treated differently under State blue sky laws.
Tier 1 of Regulation A+ provides an exemption for securities offerings of up to $20 million in a 12-month period, while Tier 2 provides an exemption for securities offerings of up to $50 million in a 12-month period. It should be noted that an issuer offering $20 million or less of securities can elect to proceed under either Tier 1 or Tier 2 of Regulation A+. Read More
SEC Charges John McAfee, Jimmy Watson, Jr with Fraudulently Touting ICOs
On October 6, 2020, the Securities and Exchange Commission (the “SEC”) charged businessman and computer programmer, John McAfee, for promoting investments in initial coin offerings (ICOs) to his Twitter followers without disclosing that he was paid to do so. McAfee’s bodyguard, Jimmy Watson, Jr., was also charged for his role in the alleged scheme.
According to the SEC’s complaint, McAfee promoted multiple ICOs on Twitter, allegedly pretending to be impartial and independent even though he was paid more than $23 million in digital assets for the promotions. When certain investors asked whether he was paid to promote the ICOs, McAfee allegedly denied receiving any compensation from the issuers. The complaint alleges that McAfee made other false and misleading statements, such as claiming that he had personally invested in some of the ICOs and that he was advising certain issuers. Read More
Edward T. Kelly, Aceto Corporation Controller, Charged with Insider Trading
On September 23, 2020, the Securities and Exchange Commission (the “SEC”) charged Edward T. Kelly the former Controller of Aceto Corporation, with insider Trading. According to the SEC’s complaint, after Kelly retired from Aceto in March 2018, the company formally retained him as a consultant to assist in closing Aceto’s books for the quarter ending March 31, 2018. While working as a consultant, Kelly allegedly obtained non-public information about Aceto’s poor sales and earnings results and a pending impairment charge. The complaint alleges that while in possession of this information, Kelly sold all of his Aceto shares and exercised and sold his in-the-money stock options in advance of the information being released, profiting and avoiding losses of more than $85,000 in the aggregate. Read More
SEC Obtains Final Judgment Against Nicholas Tornello, Hill International, Inc
On October 1, 2020, the U.S. District Court for the Eastern District of Pennsylvania entered a final consent judgment against Nicholas Tornello, a former senior accountant at Hill International, Inc.
The Security and Exchange Commission’s (the “SEC”) complaint, filed on January 16, 2020, alleged that Tornello failed to correct approximately $5 million in accounting errors relating to foreign currency exchange losses incurred by Hill, and attempted to “bleed” those losses out over time. As alleged, this conduct reduced the negative impact of the losses, resulting in overstated net income on the company’s financial statements.
Without admitting or denying the SEC’s allegations, Tornello consented to the entry of the final judgment, which enjoins him from violating the record-keeping and internal controls provisions of Section 13(b)(5) of the Securities and Exchange Act of 1934 and Rule 13b2-1 thereunder, and from aiding and abetting violations of the books and records and reporting provisions of 13(a) and13(b)(2)(A) of the Exchange Act and Rules 12b-20, 13a-1, 13a-11, and 13a-13 thereunder. The judgment also orders Tornello to pay a $25,000 civil penalty. Read More
SEC Proposes Exemptive Relief for Finders
At its October 7, 2020 open meeting, the Securities and Exchange Commission (the “SEC”) voted to propose exemptive relief for certain finders engaged in raising capital from accredited investors. If the proposal is adopted, it would allow them to receive commissions and other transaction-based compensation without registration as a broker-dealer under Section 15 of the Securities Exchange Act of 1934 (the “Exchange Act”).
The measure will apply only to finders who wish to assist issuers engaged in offerings that rely on exemptions from registration under the Securities Act of 1933 (the “Securities Act”) such as Regulation A, Regulation D, or Regulation Crowdfunding. In all cases, the finders must deal only with individuals or entities they reasonably believe to be accredited investors. Read More
SEC Amends Rule 15c2-11, Form 211 Amendments
On September 16, 2020, the Securities and Exchange Commission (the “SEC”) adopted amendments to Securities Exchange Act Rule 15c2-11. In early 2020, we wrote about amendments to Rule 15c2-11 that were proposed by the SEC in September 2019. The object of the proposed changes was, according to the regulator, to ensure that over-the-counter issuers—better known as penny stocks—would make “current information” available to prospective investors.
SEC Rule 15c2-11, last revised in 1991, provided that before quotations could be initiated for an OTC issuer, the issuer would need to find a sponsoring market maker who would, relying on “current information” provided by the company, compile and submit a Form 211 to the Financial Industry Regulatory Authority (“FINRA”). FINRA would process the form, and the stock could then begin to trade. For one month, it would only be quoted by the sponsoring market maker; subsequently, other market makers could “piggyback” on the Form 211 and publish their own quotes. Read More
Can I Use an Online Portal For My Rule 506(c) Offering?
Online Platforms for Rule 506(c) Offerings
The most common exemption from SEC Registration is Rule 506(c) of Regulation D which provides for two unique exemptions from SEC registration that allow the issuer to raise unlimited amounts of capital if it complies with the specific requirements of each rule. Rule 506(b) permits sales to up to 35 non-accredited investors and an unlimited number of accredited investors while Rule 506(c) allows sales to be using general solicitation and advertising so long as the issuer verifies that all investors are accredited purchasers. The JOBS Act provided a limited exemption for online investment platforms from registration as a broker-dealer for certain offerings made pursuant to 506(c) of Regulation D. This exemption from broker-dealer registration is available if the person: Read More
SEC Amends Regulation S-K Item 101, 103 and 105
On August 26, 2020, the Securities and Exchange Commission (the “SEC”) finalized its proposed rule amending the disclosure requirements under Items 101, 103, and 105 of Regulation S-K. The revisions to Regulation S- K modernize SEC disclosure requirements and provide investors with more meaningful information about an issuer’s business, legal proceedings, and risks of an investment in the issuer’s securities. They also reduce the burden on issuers to disclose certain information that might be immaterial to the issuer’s business. Items 101, 103 and 105 have not been substantially revised for over 30 years. Issuers conducting direct public offerings or filing registration statements on Form F-1 or Form S-1 should be aware of these changes and adjust their filings appropriately.
The revisions to Regulation S-K will become effective 30 days after the final rule is published in the Federal Register. Read More
SEC Amends Accredited Investor Definition – Rule 506 Offerings
New Accredited Investor Rules
Rule 506 Offerings are the most common of the Regulation D exemptions from registration under the Securities Act of 1933, as amended (the “Securities Act”). Rule 506 contains two distinct offering exemptions. Rule 506(b) and Rule 506(c). Rule 506 (b) provides an exemption to an unlimited number of accredited investors and up to thirty-five non-accredited investors without the use of general solicitation and advertising while Rule 506(c) allows the issuer to sell to an unlimited number of accredited investors so long as it verifies that each investors is an accredited investor.
The first question most issuers ask when considering an offering under Rule 506 is “what is an accredited investor”?
Among other requirements, Rule 506(b) allows sales of securities to up to 35 non-accredited investors while Rule 506(c) allows sales to an unlimited number of accredited investors. The SEC’s amendment to the definition of Accredited Investor now includes knowledge-based criteria. The SEC Amendment expands the definition of “accredited investor” in Rule 501(a) to include the following: Read More
SEC Says toxic funder John M. Fife is an Unregistered Dealer
On September 3, 2020, the Securities and Exchange Commission (“SEC”) filed an enforcement action against John M. Fife and five entities he owns and controls: Chicago Venture Partners, L.P. (“CVP”), Iliad Research and Trading, L.P. (“Iliad”), St. George Investments LLC (“St. George”), Tonaquint, Inc. (“Tonaquint”), and Typenex Co-Investment, LLC (“Typenex”). According to the SEC, Fife and his companies had acted for years as securities dealers, but failed to register with the SEC and with the Financial Industry Regulatory Authority (“FINRA”) as the Securities Exchange Act of 1934 (“Exchange Act”) requires.
Fife has operated as what’s called a “toxic lender” for many years. Microcap companies trading on the over-the-counter market typically have limited access to traditional financing. Desperate for cash, they sign on with financiers like Fife who purchase securities—usually convertible promissory notes or convertible debentures—from them. The financiers charge extremely high interest, but that’s the least of their clients’ problems. Upon conversion, the lenders enjoy a discount to market price that may be as high as 60 percent, and higher in the event of default by the issuer. As he converts portions of his note and sells the resulting stock into the market in a series of tranches, the stock’s price plummets. That is why these kinds of instruments are called “death spiral convertibles.” Eventually, the dilution caused by the conversions may force the issuer to reverse split the company’s stock. Sometimes it drives the company into bankruptcy. Read More
SEC Says Ibrahaim Almagarby and Microcap Equity Group Are Unregistered Dealers
We’ve previously written about Securities and Exchange Commission (“SEC”) enforcement actions pending against John Fierro and Justin Keener alleging unregistered dealer activity. Filed in February and March 2020 respectively, they are similar to a lawsuit the agency brought against Ibrahaim Almagarby and his company Microcap Equity Group LLC (“Microcap Equity”) in late 2017. The Almagarby suit moved slowly, but the order handed down by Judge Marcia Cooke on August 17, granting the SEC’s motion for summary judgment and denying the defendants’ cross-motion for summary judgment, will bring the matter to an end quickly.
The recent ruling in the SEC action against Ibrahim Almagarby and Microcap Equity addresses unregistered dealer activity by businesses engaged in the purchase of notes and/or bonds convertible at a discount to the market price of the underlying security. These types of transactions are most often the result of toxic note financings provided to penny stock companies; they sometimes feature conversion ratios as dramatic as an 80 percent discount from the issuer’s trading price.
Business Identity Theft: State of the Industry Report
What Are They and How to Protect Your Company From Thieves
By Ralph Gagliardi
Identity thieves don’t just target people – they prey on businesses, too. Their schemes vary widely, from the unimaginably complex to the absurdly simple. But in every case, their effects can be devastating to the business involved and its personnel.
Business identity theft is when criminals hijack a business’s name to plunder its assets, credit and/or reputation. The crime comes in a variety of forms, from scammers merely impersonating a business to fraudsters filing fraudulent paperwork to take over a company. However it’s done, the goal is always the same: To exploit the business for the criminal’s financial gain. That can mean purchasing luxury cars or dozens of cell phones on company credit and selling them for a quick profit. It can mean seizing company assets, like a piece of property stashed in a holding company, and transferring it to another business entity, where it’s sold to an unsuspecting third party. Or it can be masquerading as your business to exploit your good reputation and defrauding your current or potential customers. Read More
AmTrust and Ronald E. Pipoly, Jr Charged with Faulty Loss Reserves Disclosures
On June 17th, 2020, the Securities and Exchange Commission (the “SEC”) charged international insurance company AmTrust Financial Services, Inc. and its former CFO Ronald E. Pipoly Jr. with failing to disclose material facts about how the company estimated its insurance losses and reserves. They have agreed to pay a combined $10.5 million to settle the SEC’s charges. Read More
SEC Obtains Final Judgments Against Daniel Adams, Michael Flanders, Spiderworx Media LLC, and An L.A. Minute LLC
SEC Action Daniel Adams Michael Flanders SEC Action Daniel Adams Michael Flanders
On June 16, 2020, the Securities and Exchange Commission (the “SEC”) has obtained final judgments against movie director and convicted felon Daniel Adams, music producer Michael Flanders, and companies under their control for defrauding two investors in connection with financing the movie entitled An L.A. Minute. Read More
SEC Says Toxic Financing Lender and Dilution Funder John Fierro is a Dealer Not a Trader
Dilution Funders and Dilution Financings Challenged by SEC
We recently wrote about two interesting SEC enforcement actions that examine the question of whether the individuals and entities that purchase convertible promissory notes from public companies are “dealers” according to the definition established in Section 15(a)(1) of the Securities and Exchange Act of 1934 (“Exchange Act”). Informally known as “toxic lenders” or “dilution funders” because the terms of their financing agreements contain provisions that almost always result in harm to investors and issuers alike, they’re considered by many to be the scourge of the penny stock market. Typically, the notes they buy can be converted at any time, often at a discount to market price of 70 percent or more. As the lender converts and sells, stock price drops. To avoid making insider filings to the SEC, the lender’s financing agreements specify that he may own no more than 4.99 percent of the company’s stock at any time. But that in no way stops him from converting his note continuously, in a succession of tranches. Since the conversion ratio is pegged to the security’s recent average bid price, every time he converts, he gets more stock than the time before. As he sells tranche after tranche, the company’s stock price enters freefall. Sometimes the only remedy for the issuer is a large reverse split.
Read More
SEC Obtains Judgment Against Giga Entertainment, Inc. CEO Gary Nerlinger
On June 2, 2020, the U.S. District Court for the Eastern District of New York entered a final judgment as to monetary relief against the former de facto CEO of Giga Entertainment Media, Inc., Gary S. Nerlinger, whom the Securities and Exchange Commission (the “SEC”) previously charged in connection with a scheme to mislead investors. Read More
SEC Settles with Three Defendants in Boiler Room Scheme
On June 11, 2020, the Securities and Exchange Commission (the “SEC”) announced that it has obtained final judgments by consent against Ronald Hardy, Anthony Vassallo, and Sergio Ramirez charged for their roles in a $10 million boiler room scheme. The SEC’s complaint, filed on July 12, 2017, alleged that Ronald Hardy and Anthony Vassallo, through boiler rooms they controlled, and together with Sergio Ramirez and other employees, engaged in a fraudulent scheme using threatening and deceitful sales tactics to pressure retail investors to purchase penny stocks. The defendants used information they learned about the victims’ purchase orders to facilitate the placement of opposing sell orders to dump shares owned by participants in the fraudulent scheme. Read More
SEC Reaches Settlements with Traders in Newswire Hacking and Trading Scheme
On June 10, 2020, the Securities and Exchange Commission (the“ SEC”) announced that it has obtained court approval of settlements with eight defendants: Arkadiy Dubovoy, Igor Dubovoy, Southeastern Holding and Investment Company LLC, APD Developers, Inc., Leonid Momotok, Aleksandr Garkusha, Vladislav Khalupsky, and Memelland Investments Ltd, charged in connection with an international scheme to trade on hacked news releases.
In August 2015, the Commission filed a civil action and then an amended complaint in New Jersey federal court charging the eight settling defendants, together with more than 20 others, with securities fraud. According to the amended complaint, Ukrainian hackers used advanced techniques to hack into newswire services and steal hundreds of corporate earnings releases before the newswires released them publicly. Read More
What Is a Control Person? Control Securities, Resale Requirements
What are Control Securities?
Sales of securities by affiliates and control persons of publicly traded companies are subject to requirements not applicable to other sellers under federal securities laws. Rule 405 of the Securities Act of 1933, as amended (the “Securities Act”) contains definitions of each.
- An “affiliate” of, or person “affiliated” with, a specified person, is a person that directly, or indirectly through one or more intermediaries, controls or is controlled by, or is under common control with, the person specified.
- The term “control” (including the terms “controlling,” “controlled by” and “under common control with”) means the possession, direct or indirect, of the power to direct or cause the direction of the management and policies of a person, whether through the ownership of voting securities, by contract, or otherwise.
SEC Form 3, Insider Reporting Requirements
Anyone who is an insider of a public company subject to SEC reporting requirements (“SEC Reporting Company”) must file a Form 3 with the Securities and Exchange Commission (“SEC”) under Section 16 of the Securities Exchange Act of 1934, as amended (the “Exchange Act”).
Certain events make a person a Section 16 insider:
- When the issuer first lists on the New York Stock Exchange (“NYSE”) or NASDAQ stock market (“NASDAQ”) pursuant to Section 12(b) of the Exchange Act,
- Upon the company’s first registration statement under Section 12(g) of the Exchange Act becoming effective, or
- Upon a person becoming a director or officer or beneficially owning 10% of the company’s securities, directly or indirectly.
SEC Trading Suspensions Under the Securities Exchange Act
SEC Trading Suspensions under Exchange Act Section 12(k)
Section 12(k)(1)(A) of the Exchange Act, grants the SEC the authority to issue trading suspensions for up to 10 business days if it believes the trading suspension is in the public interest protects investors. When the SEC issues a trading suspension pursuant to Section 12(k), trading in the security is halted for the period set forth in the order which is typically the full 10 days. Once the trading suspension is over, few companies resume normal trading activity.
If issuer’s securities are listed on a national securities exchange such as the NYSE or NASDAQ, they will resume trading after the trading suspension ends. For companies quoted on the OTC Markets, resuming trading is not as easy. OTC Markets issuers must locate a market maker to submit a Form 211 in compliance with FINRA Rule 15c2-11. Few market makers are willing to assume the liability of filing a Form 211 for a company that has been suspended by the SEC. Read More
SEC Charges Jason C. Nielsen in Manipulative Trading Scheme Involving Covid-19 Claims
On June 10, 2020,the Securities and Exchange Commission (the “SEC”) charged Jason C. Nielsen, a penny stock trader in Santa Cruz, California, with conducting a fraudulent pump-and-dump scheme in the stock of a biotechnology company by making hundreds of misleading statements in an online investment forum, including a false assertion that the company had developed an “approved” COVID-19 blood test. Read More
SEC Enters Final Judgment Against Brandon Copeland, E.B. & Copeland Capital, Inc.
On June 17th, 2020, the Securities and Exchange Commission (the “SEC”) charged international insurance company AmTrust Financial Services, Inc. and its former CFO Ronald E. Pipoly Jr. with failing to disclose material facts about how the company estimated its insurance losses and reserves. They have agreed to pay a combined $10.5 million to settle the SEC’s charges. Read More
SEC Obtains Preliminary Injunction Against Paul Horton Smith, Sr., Northstar Communications, LLC, Planning Services, Inc. and eGate
On June 3, 2020, the United States District Court for the Central District of California entered a preliminary injunction and orders freezing assets and imposing other relief against California-registered investment adviser Paul Horton Smith, Sr. and his entities in connection with a Ponzi scheme targeting senior citizens. Read More
SEC Obtains Judgements Against Stiefel Laboratories and Charles Stiefel
On June 5, 2020, the Securities and Exchange Commission (the “SEC”) announced that it has obtained final judgments of $37 million against Stiefel Laboratories and Charles Stiefel. According the the SEC, Stiefel and Stiefel Labratories defrauded shareholders, who were mostly company employees, by having Stiefel Laboratories buy back their stock at severely undervalued prices.
The SEC alleged that Stiefel Laboratories and Charles Stiefel used artificially low valuations for stock buybacks and failed to disclose information that would have alerted employee shareholders their stock was worth much more than the price the company paid them. For example, according to the complaint the company failed to disclose negotiations for the sale of the company that ultimately resulted in GlaxoSmithKline PLC purchasing Stiefel Laboratories for a share price more than four times higher than the share price the company paid to employee shareholders.
Is My Toxic Lender and Dilution Funder a Dealer? – SEC Toxic Financing Actions
How Dilution Funders Operate
Everyone interested in penny stocks, either as an investor or an observer, knows that nearly all microcap issuers are in perpetual need of financing. Reputable banks are usually uninterested in lending, and government entities like the Small Business Association are slow to process applications. In the end, a great many small public companies turn to what are sometimes called toxic or dilution funders to meet their needs. In these dilution financings, the lenders’ terms contain special features that almost always result in harm to investors, and to the company itself. These funders operate by purchasing convertible promissory notes from their client companies using documents drafted by their sometimes complicit lawyers. Typically, the notes can be converted at any time into the companies’ common stock. Worse yet, when the lender converts, he receives an amount of stock fixed at a pre-negotiated discount to market that can be as large as 70 percent. The notes often contain default and penalty provisions providing lenders with the ability to receive even more shares if the stock price drops below a certain level, or upon the occurrence of certain events, such as non-compliance with SEC reporting requirements or other obligations. Read More
