Securities Industry Commentator by Bill Singer Esq

June 24, 2019

Wells Fargo Banker and Broker Loses Humpty Dumpty FINRA Arbitration
( Blog) humpty dumpty/
In FINRA arbitration practice, you got a rule laying out the minimal content to be disclosed in an intra-industry or a public customer FINRA Arbitration Decision. Then you got a rule that provides for an optional "rationale." Thereafter, FINRA's Arbitration Code has a rule about a so-called Explained Decision. If all parties ask for an Explained Decision, then the Chair is supposed to write one (and there's even an extra $400 honorarium tossed in for the effort). So, how the hell do we get a FINRA Explained Decision when no party asked for one? Simple. You listen to Humpty Dumpty.
In the "Summary" portion of a Complaint filed in the United States District Court for the Southern District of New York, the SEC asserted that Defendants Gregory T. Dean and Donald J. Fowler engaged in the following:

1. This action concerns the conduct of two registered representatives, Dean and Fowler, who recommended to customers a high-cost trading strategy consisting of the excessive buying and selling of stocks. This strategy benefitted Dean and Fowler because the frequency of the trading generated substantial commissions and other fees. The customers who trusted Dean  and Fowler and relied on their supposed stock-picking expertise, however, ended up with enormous losses. 

2. The uniform trading strategy followed by Dean and Fowler in 27 customer accounts at J.D. Nicholas & Associates, Inc. ("J.D. Nicholas"), a now-defunct broker-dealer based in Syosset, NY, is summarized in the Attachment. As the Attachment shows, the highcost, excessive trading generated ill-gotten gains for Dean and Fowler while their customers' account balances dwindled away. 

3. Dean's and Fowler's conduct violated the antifraud provisions of the federal securities laws in two respects. First, Dean and Fowler recommended a trading strategy to 27 customers without any reasonable basis to believe that the strategy was suitable for anyone. They knew or should have known that, in view of the excessive in-and-out trading and the cost structure, their strategy was bound to lose money in each of the 27 customer accounts. Second, Dean and Fowler engaged in churning with regard to at least 3 of the 27 customer accounts. 

Prior to trial, Defendant Dean admitted, among other things, that he knowingly or recklessly made trade recommendations to his customers with no reasonable basis, and that his conduct violated the federal securities laws. On June 10, the SEC obtained a final judgment against Dean, whoagreed to pay $253,881 in disgorgement, $50,521 in prejudgment interest, and a civil penalty in the amount of $253,881. Fowler was convicted by jury of violating Section 17(a) of the Securities Act and Section 10(b) of the Securities Exchange Act and Rule 10b-5 thereunder. 

Former CEO of Chicago-Area Public Company Pleads Guilty in Market Manipulation Scheme (SEC Release)
Former Wellness Center USA, Inc. ("WCUI") Chief Executive Officer, President, and Chairman of the Board Andrew J. Kandalepas pled guilty in the United States District Court for the Northern District of Illinois to one count of securities fraud. Previously, Kandalepas consented to a judgment in a parallel SEC enforcement action. As set forth in part in the SEC Release:

[B]etween December 2012 and June 2015, Kandalepas bought and sold shares of WCUI for the purpose of artificially inflating the stock price. Many of his trades occurred at or near the close of normal trading hours in a form of market manipulation known as "marking the close." According to the plea agreement, Kandalepas netted at least $136,176 in trading profits for his personal use.

On April 12, 2018, the SEC charged Kandalepas with, among other things, manipulating WCUI's stock and with making false and misleading statements in WCUI's SEC filings and press releases. On September 25, 2018, the United States District Court for the Northern District of Illinois entered a consent judgment against Kandalepas permanently enjoining him from violating the antifraud provisions of Sections 17(a) of the Securities Act of 1933 and Section 10(b) of the Securities Exchange Act of 1934 and Rule 10b-5 thereunder, and the broker registration provisions of Section 15(a) of the Exchange Act. The judgment also bars Kandalepas from serving as an officer or director of a public company and from participating in penny stock offerings, and orders disgorgement and interest and penalties to be determined by the court. Kandalepas consented to the entry of the judgment without admitting or denying the allegations in the complaint.

Former Kiddar Capital CEO Sentenced to Prison (DOJ Release)
Todd Elliott Hitt pled guilty to securities fraud and was sentenced in the United States District Court for the Eastern District of Virginia to six and a half years in prison. As set forth in part in the DOJ Release, Hitt had:

solicited approximately $30 million from investors for a variety of real estate and venture capital investments in the Washington, D.C. area from 2014 through August 2018. The investments included Hitt's solicitation of approximately $17 million from investors in order to purchase a five-story office building adjacent to a planned future stop on the Silver Line in Herndon. Hitt made false statements and material omissions to investors by failing to disclose that a significant portion of the monies raised were commingled with other unrelated investment projects, used for personal spending to support an extravagant lifestyle and new investor's funds used to pay off old investors in a Ponzi-like scheme. Hitt's fraudulent conduct resulted in investor losses of approximately $20 million.
Daniel B. Rudden pled guilty to wire in the United States District Court for District of Colorado and was sentenced to 121 months in prison plus three years of supervised release; and he was ordered to pay $19,609,905.21 in restitutuion. As set forth in part in the DOJ Release:

[R]udden was the President and sole owner of Financial Visions, Inc. (FV). FV's business model was based on taking assignments on life insurance policies in order to pay for funeral expenses. When a family experienced the death of a family member and could not afford the funeral expenses, FV would pay the funeral home and/or cemetery for those expenses and take an assignment on the deceased's life insurance proceeds. When the insurance company paid the proceeds, it would pay FV directly for the funeral expenses that FV had fronted. FV charged the family of the deceased a 4 to 5 percent fee for this service.

Individuals who decided to invest in FV received a promissory note signed by the defendant. Through the promissory note, the defendant promised to pay back to the investor the principal amount invested plus interest. Most investors were promised 12% simple interest per year on their principal amount invested, to be paid on a quarterly basis.

Over the years, the defendant continued to take in money from new investors, but the number of funeral homes using FV's services did not continue to grow at a commensurate rate. As a result, FV owed investors more and more in interest payments while FV was not making a profit sufficient to sustain such payments. The defendant ultimately began using later investors' funds to make the interest payments to earlier investors.  The Ponzi scheme ended up defrauding 175 investors out of more than $19 million.  More than 65 victims lost over $100,000 each, and two people lost over $1 million. 

The scheme came to a head when the defendant stopped being able to pay out "interest" and could not give investors a refund of their principal balance when demanded. Some investors reported the defendant to state and federal authorities. On July 9, 2018, the defendant himself emailed his investors and admitted that FV had become a Ponzi scheme. As stated in the plea agreement, the government maintains that, based on profit and loss statements, FV was not a profitable business model from its inception.  

SEC Obtains Judgment Against Ponzi Scheme Operator (SEC Release)
The United States District Court for the Eastern District of Virginia entered a final default judgment against investment advisory firm CM Capital Management, LLC and its sole owner Edward Lee Moody, Jr. that permanently enjoined them from violating the antifraud provisions of Section 17(a) of the Securities Act, Section 10(b) of the Securities Exchange Act  and Rule 10b-5 thereunder, and Sections 206(1) and 206(2) of the Investment Advisers Act of 1940. Also, Moody  agreed to pay $3,025,067 disgorgement plus $32,181 prejudgment interest, which shall be deemed satisfied by the Orders of Forfeiture and Restitution entered against him in the criminal action. The SEC charged te firm and Moody with the SEC charged Edward Lee Moody, Jr. and his wholly-owned investment adviser firm CM Capital Management, LLC, with operating a nine-year Ponzi scheme that defrauded dozens of retail investors out of about $5 million. In settling the SEC's charges against him, Moody acknowledged that he pled guilty in a parallel criminal action for which he was entenced to 13 years in prison. In a related SEC administrative proceeding, Moody agreed to the issuance of an SEC Order permanently barring him from associating with any broker, dealer, investment adviser, municipal securities dealer, municipal advisor, transfer agent, or national recognized statistical rating organization.
Jason "J.R." Trowbridg; Robin Chapin; Anna Hardy; Shamair Brison; Rebecca Fogle; and Sarah Bromfield were Indicted in the United States District Court for the Northern District of New York with conspiracy to commit computer fraud, accessing a protected computer and obtaining information for commercial advantage and private financial gain, and aggravated identity theft. As set forth in the DOJ Release:

The defendants operated or were employed by Paymerica Corporation, a Maryland-based company involved in researching place-of-employment information to assist debt collectors.  According to the indictment, the defendants conspired to gain unauthorized access to computers used by state governments in New York and other states for processing unemployment insurance applications.  Members of the conspiracy created user accounts in the names of their victims, without the victims' authorization, to obtain information about the victims' current employers.  The defendants then sold this information to third-party debt collectors seeking to collect money from the victims, including by garnishing the victims' wages.

SEC Commissioner Peirce takes on the so-called Environmental, Social, and Governance ("ESG") factors by which corporations are now rated. Frankly, ESG has become a cottage industry for many self-professed experts, who seem to resort to some dubious methodology. Moreover, activists of all stripes latch on to various ESG ratings as indicative of corporate greed and corporate mismanagement, or, on the other end of the spectrum, the unnecessary intrusion of pseudo-science and socialism into the exercise of business judgment. Not one to shy away from expressing her opinions, Commissioner Peirce warns in part that {Ed: footnotes omitted]:

[H]ere too we see labeling based on incomplete information, public shaming, and shunning wrapped in moral rhetoric preached with cold-hearted, self-righteous oblivion to the consequences, which ultimately fall on real people. In our purportedly enlightened era, we pin scarlet letters on allegedly offending corporations without bothering much about facts and circumstances and seemingly without caring about the unwarranted harm such labeling can engender. After all, naming and shaming corporate villains is fun, trendy, and profitable.

E, S, and G tend to travel in a pack these days, which makes it hard to establish reliable metrics for affixing scarlet letters. Governance at least offers some concrete markers, such as whether there are different share classes with different voting rights, the ease of proxy access, or whether the CEO and Chairman of the Board roles are held by two people. Even with these examples, however, people do not agree on which way they cut, and they may not cut the same way at every company. In comparison to governance, the environmental and social categories tend to be much more nebulous. The environmental category can include, for example, water usage, carbon footprint, emissions, what industry the company is in, and the quantity of packing materials the company uses. The social category can include how well a company treats its workers, what a company's diversity policy looks like, its customer privacy practices, whether there is community opposition to any of its operations, and whether the company sells guns or tobacco. Not only is it difficult to define what should be included in ESG, but, once you do, it is difficult to figure out how to measure success or failure.

The SEC adopted new rules for for security-based swap dealers.
READ the full-text Final Rule
As set forth in part in the SEC Release, the rules address the following four areas:
  • They establish minimum capital requirements for security-based swap dealers and major security-based swap participants for which there is not a prudential regulator (nonbank SBSDs and MSBSPs).  They also increase the minimum net capital requirements for broker-dealers that use internal models to compute net capital (ANC broker-dealers).  In addition, they establish capital requirements tailored to security-based swaps and swaps for broker-dealers that are not registered as an SBSD or MSBSP to the extent they trade these instruments. 
  • They establish margin requirements for nonbank SBSDs and MSBSPs with respect to non-cleared security-based swaps.
  • They establish segregation requirements for SBSDs and stand-alone broker-dealers for cleared and non-cleared security-based swaps.
  • They amend the Commission's existing cross-border rule to provide a means to request substituted compliance with respect to the capital and margin requirements for foreign SBSDs and MSBSPs, and provide guidance discussing how the Commission will evaluate requests for substituted compliance.