Securities Industry Commentator by Bill Singer Esq

June 5, 2019

Wall Street Goes Silent On #METOO (The Intercept in partnership with TypeInvestigations by Susan Antilla)
As always, veteran industry reporter Susan Antilla asks the uncomfortable questions and more than a few folks will likely squirm in discomfort. In part, Antilla notes that at a:

two-day conference of diversity experts in the securities industry in New York in late May, not one of the seven panels addressed the challenge of sexual harassment in the workplace. Nor was there interest in addressing concerns about sexual harassment from participants. When one moderator invited written questions, I filled out a card asking the panel of financial regulators about harassment at their agencies and at the companies they regulated. The moderator read out the other audience questions but ignored mine.
Sometimes when you initiate litigation you don't know the names of all the parties that you want to sue.  In such cases, you will often see a caption list "John Doe, Respondent" or "John Does #1 - #3, Defendants." As the lawsuit makes its way through Discovery, those unknown names may become disclosed, and, accordingly, the Plaintiff or Claimant may move to amend the pleadings in order to identify the actual name of any John Doe.  Depending upon when such a motion is made, a whole host of due process issues may arise -- not the least of which is whether the last-minute amendment would constitute litigation by sandbag and violate a John Doe's due process rights. I've been through the FINRA desert on a horse with no name. It felt good to be out of the arbitration.

Silicon Valley Computer Executive Convicted of Defrauding Investors After Soliciting Money Via Crowdfunding (DOJ Release)
A jury in the United States District Court for the Northern District of Illinois convicted Jeffrey Batio on six counts of mail fraud and six counts of wire fraud in connection with his defrauding investors in his computer companies after soliciting and obtaining some of the money via crowdfunding. As set forth in part in the DOJ Release:

Batio owned and controlled two computer businesses, Armada Systems LLC and Idealfuture Inc.  The companies claimed to produce a portable computer that would combine a laptop, tablet and smart phone into one device.  The 3-in-1 apparatus was known at various times by the names Stealth, IF Convertible, and Dragonfly Futurefon.  The companies also claimed to produce a device called the Radian, which was billed as a multi-screen laptop computer.

Evidence at trial revealed that for more than a decade Batio made material misrepresentations about his companies and products.  For example, Batio falsely claimed that Armada and Idealfuture had completed the engineering on the 3-in-1 computer and the multi-screen system, and that the products were close to being brought to market.  In reality, Batio knew the products were not complete and that production would not start within the promised timeframe.  Batio also claimed to be involved in discussions with large technology companies concerning partnership deals, licensing arrangements and marketing agreements, when, in fact, Batio's contacts with those companies typically consisted of nothing more than his opening sales pitch.

The fraud scheme began in 2003 and continued until 2016.  Batio originally sold membership shares in his companies and offered his products for advance sales that were never fulfilled.  From 2003 to 2014, Batio defrauded victims out of $5 million.  As the years passed and he failed to produce or license any products, Batio in 2014 began to solicit funds on the crowdfunding website  From 2014 to 2016, Batio raised more than $700,000 on Indiegogo from investors all over the world by fraudulently promoting and selling the 3-in-1 device.
The SEC filed a subpoena enforcement action in the United States District Court for the Northern District of Illinois against Covalent Collective, Inc. f/k/a Doyen Elements International, Inc. f/k/a Advantameds Solutions, Inc. ("Doyen") for failure to produce documents in an investigation.The SEC alleges that Doyen, through its founder, Geoffrey Thompson, may have violated the registration provisions of the securities laws by engaging in an unregistered offering of securities, and may also have made misleading representations to investors and potential investors about the operations, acquisitions, and projected stock price of Doyen and related entities. The SEC Release admonishes that:

The SEC is continuing its fact-finding investigation and, to date, has not concluded that anyone has violated the securities laws.

Bill Singer's Comment: From what I understand, some 1,800 SEC employees volunteered to be part of the fact-finding investigation. Chairman Clayton has expressed concern about the lack of progress and has asked why one conference room is continually filled with smoke and empty boxes of pizza and Oreo cookies.  Inside sources declined to comment but did giggle.
In a Complaint filed in the United States District Court for the Southern District of New York,, the SEC charged Kik Interactive Inc.with violating the registration requirements of Section 5 of the Securities Act; and the federal regulator seeks a permanent injunction, disgorgement plus interest, and a penalty.  As set forth in part in the SEC Release:

[K]ik had lost money for years on its sole product, an online messaging application, and the company's management predicted internally that it would run out of money in 2017.  In early 2017, the company sought to pivot to a new type of business, which it financed through the sale of one trillion digital tokens.  Kik sold its "Kin" tokens to the public, and at a discounted price to wealthy purchasers, raising more than $55 million from U.S. investors.  The complaint alleges that Kin tokens traded recently at about half of the value that public investors paid in the offering.

The complaint further alleges that Kik marketed the Kin tokens as an investment opportunity.  Kik allegedly told investors that rising demand would drive up the value of Kin, and that Kik would undertake crucial work to spur that demand, including by incorporating the tokens into its messaging app, creating a new Kin transaction service, and building a system to reward other companies that adopt Kin.  At the time Kik offered and sold the tokens, the SEC alleges these services and systems did not exist and there was nothing to purchase using Kin.  Kik also allegedly claimed that it would keep three trillion Kin tokens, Kin tokens would immediately trade on secondary markets, and Kik would profit alongside investors from the increased demand that it would foster.  The Kin offering involved securities transactions, and Kik was required to comply with the registration requirements of the U.S. securities laws.

SEC Obtains Final Judgment Against Operator of Ponzi Scheme Targeting Retail Investors (SEC Release)
In a Complaint filed in the United States District Court for the Middle District of Pennsylvania, the SEC charged James E. Hocker with securities fraud. The Complaint alleged that Hocker falsely promised investors guaranteed returns of between 10% and 30% from investments he would make on their behalf in the S&P 500 and other unspecified investment vehicles; however, he did not invest any of the investors' funds and used the funds for his own personal expenses. Previously, Hocker pled guilty in a parallel criminal action and was sentenced to 17 years imprisonment and ordered to pay restitution of $1,495,782 for defrauding investors. In a final judgment in the SEC's action, Hocker was enjoined from violating the antifraud provisions of Section 17(a) of the Securities Act and Section 10(b) of the Securities Exchange Act  and Rule 10b-5 thereunder, and ordered to pay  $1,495,782 disgorgement, which will be deemed satisfied by the restitution ordered in the criminal action.

Court Grants Final Judgment Against Promoter of Pyramid Scheme (SEC Release)
The Securities and Exchange Commission obtain a final judgment in the United States District Court for the District of Massachusetts against Faith Sloan, a promoter of the allegedly fraudulent TelexFree pyramid scheme targeting Latino communities. The judgment permanently enjoins Sloan from violating the registration provisions of Section 5 of the Securities Act and imposes a conduct-based injunction; also, she is ordered to pay $1,271,215 in disgorgement and prejudgment interest and a civil penalty of $7,500. The monetary portion of the judgment is deemed partially offset by an order requiring Sloan to transfer certain assets to settle an adversary action in a related bankruptcy case. 
Previously, the SEC  obtained final judgments by consent against TelexFree, TelexFree's co-owner and President and its Chie Financial Officer, its international sales director, a promoter of the pyramid scheme, another promoter of the pyramid scheme, and a third promoter, who also was ordered to serve prison time for civil contempt arising from his repeated violations of court orders.

Hedge Fund Adviser to Pay $5 Million for Compliance Failures Related to Valuation of Fund Assets.In the Matter of  Deer Park Road Management Company LP and Scott Burg, Respondents (SEC Order Instituting Administrative and Cease-and-Desist Proceedings, Making Findings, and Imposing Remedial Sanctions and a Cease-and-Desist Order; Invest. Adv. Act Rel. No. 5245; Admin. Proc. File No. 3-19190 / June 4, 2019)
Without admitting or denying the findings in the SEC Order, Deer Park Road Management Company LP and its Chief Investment Officer Scott Burg consented to a Censure of Deer Park and both agree to cease-and-desist  from committing or causing any violations and future violations of a provision of the Investment Advisers Act requiring reasonably designed policies and procedures. Additionally, Deer Park will pay a $5 million penalty, and Burg will pay a $250,000 penalty. As set forth in the "Summary" portion of the SEC Order:

1. Valuation of client assets is a critically important area for investment advisers. Failure to properly value assets can impact key areas of fund operations and also potentially lead to over or under payment of withdrawal proceeds, incorrect calculation of fees and inaccurate performance reporting, among other things. Accordingly, pursuant to Section 206(4) of the Advisers Act and Rule 206(4)-7 thereunder (the "Compliance Rule"), registered investment advisers are required to adopt and implement written compliance policies and procedures reasonably designed to prevent violations of the federal securities laws stemming from inaccurate valuations. 

2. This matter arises from violations of the Compliance Rule by Deer Park for failing to adopt and implement reasonably designed compliance policies and procedures relating to valuation of fund assets. Deer Park is a prominent private fund manager in the mortgage-backed securities space that manages over $2.5 billion in assets. 

3. From at least October 2012 through December 2015 (the "Relevant Period"), Deer Park's policies failed to address sufficiently how to conform the firm's valuations with Generally Accepted Accounting Principles ("GAAP"). Further, Deer Park's policies were not reasonably designed for its business practices, given its use of valuation models and pricing vendors, and the potential conflict of interest arising from traders' ability to determine the fair value assessment of a portion of the positions they manage. 

4. Moreover, Deer Park failed to implement its existing policy. In accordance with GAAP, Deer Park's valuation policy included a requirement to maximize the use of relevant observable inputs. During the Relevant Period, however, Deer Park, at times failed to ensure that certain residential mortgage-backed securities ("RMBS") were valued in accordance with GAAP. Specifically, Deer Park may have undervalued certain client assets by failing to maximize relevant observable inputs, such as trade prices. For example, contemporaneous explanations for certain valuations include references to market activity at a higher price than the valuation and "sell[ing] for a profit when needed." Burg was a cause of the firm's failure to implement the valuation policy that required maximizing observable inputs.