Securities Industry Commentator by Bill Singer Esq

May 23, 2019
Regulatory staff often overplay their hands. They so often win by bluffing that they habitually overrate their cases. A competent trial lawyer can often see when adversaries don't have the winning hands they've deluded themselves into thinking they do. In FINRA v. Morton, a defense lawyer smartly called FINRA's bluff, forced them to trial, and watched them get their heads handed to them twice. A regulator's "I don't believe you" should never be enough to drag someone through an enforcement action like the client was. 

FINRA OHO and NAC Reiterate That Contemporaneous Cost Is Appropriate Indicator of Prevailing Market Price In Bond Mark-Up Case. In the Matter of the FINRA Department of Enforcement, Complainant, v. J. W. Korth & Company, Respondent (FINRA Office of Hearing Officers Hearing Panel Decision, Complaint No. 2012030738501 / January 26, 2017)
As set forth in the Syllabus to the Office of Hearing Officers ("OHO") Decision:

Respondent, a fixed income dealer, charged excessive markups on 38 sales of municipal bonds and nine sales of corporate bonds, and excessive markdowns on four purchases of corporate bonds. For these violations, Respondent is ordered to pay restitution and, in lieu of a fine, to retain an independent consultant to review and monitor for fairness the firm's pricing practices. Allegations dismissed as to three sales of collateralized mortgage obligations, six sales of municipal bonds, and two sales of corporate bonds.

In fashioning its sanctions, the OHO Panel observed that [Ed: footnotes omitted]:

[A]s to sanctions, however, we do not find that the firm exhibited a pattern of charging excessive markups. We find that this misconduct is aberrant and not reflective of the firm's overall compliance record. 

We also reject the argument that J. W. Korth's rule violations were intentional or reckless. We do not find that the firm intentionally or recklessly overcharged its customers. It had in place a policy for determining markups that it openly explained to FINRA and reliably implemented. Although misguided on some of the trades at issue, we do not find that the firm exhibited a pervasive and deliberate intent to charge excessive markups. To the contrary, we find that the firm attempted to calculate fair markups, although it did not achieve this across the board.

Enforcement also argues that J. W. Korth has not accepted responsibility for its misconduct and has instead chosen to claim that its focus on profits was proper. While we agree that it is aggravating when a respondent refuses to accept responsibility for its misconduct, we do not find that J. W. Korth's actions should be so characterized. J. W. Korth launched a vigorous defense and contested the allegations against it. Through Korth, its managing partner, the firm provided a detailed explanation of the nature of its business and the many factors that it considers in making pricing determinations. Korth also explained the multiple layers of oversight that the firm employs for its pricing practices. While none of these facts excuse the firm's prices on the 42 violative trades, we will not hold against the firm that it defended its practices. 

We find that J. W. Korth's misconduct is serious and aggravated by the fact that it resulted in the firm's monetary gain and losses to customers. . . .

The OHO Decision imposed restitution to customers "in the approximate amount of $29,268." In lieu of a fine, the OHO Panel ordered Respondent in part to:

[R]etain an independent consultant with experience in establishing pricing procedures for sales and purchases of debt securities to review the firm's pricing procedures with a view towards ensuring, going forward, that J. W. Korth does not charge prices in excess of what is fair and reasonable, taking into consideration all relevant factors. . . .

Respondent J.W. Korth & Company appealed the OHO Decision to FINRA's National Adjudictory Council ("NAC"). Respondent argued that the OHO Hearing Panel used the wrong methodology to calculate markups and markdowns, and that the case law relied upon was distinguishable from the facts of this case. Further, Respondent argued that the prices it charged its customers were justified by the time and expense dedicated to each bond transaction and the complex, specialized services provided to its customers. In the Matter of the FINRA Department of Enforcement, Complainant, v. J. W. Korth & Company, Respondent (FINRA National Adjudicatory Council Decision, Complaint No. 2012030738501 / May 22, 2019)
In a 22-page Decision, the NAC affirmed the OHO Hearing Panel Decision. In pertinent part, the NAC Decision explains that:

In sum, we affirm the Hearing Panel's findings that contemporaneous cost is the appropriate indicator of the prevailing market price in this instance and that J. W. Korth failed to rebut this presumption. We further affirm that J. W. Korth has not proffered sufficient evidence to support its contention that it invested unusually significant time, energy, or expense into each of the bond sales at issue to justify its markups and markdowns. At most, it has shown only that it engaged in basic due diligence before recommending a bond, as required of all broker-dealers. Therefore, we find that the Firm violated MSRB Rules G-30 and G-17 by charging excessive markups on 38 sales of municipal securities, and NASD Rule 2440, NASD IM-2440, and FINRA Rule 2010 by charging excessive markups in nine sales of corporate debt securities and excessive markdowns in four purchases of corporate debt securities.  

Middletown, New Jersey, Investment Manager and Former Fire Chief Sentenced to 15 Years in Prison for Running Ponzi Scheme to Steal More Than $10 Million (DOJ Release)
Following a two-week trial, Vincent P. Falci was convicted in the United States District Court for the District of New Jersey on three counts of wire fraud and one count of securities fraud, and he was sentenced to 180 months in prison plus three years of supervised release, with restitution and forfeiture to be determined at a later date. As set forth in part in the DOJ Release:

Falci controlled a number of investment funds under the names "Saber Funds" and "Vicor Tax Receivables LLP." The Saber Funds were a collection of investment funds that Falci created and operated, starting in the early 2000s. Many of his earliest victims were friends, family, and associates. Falci served as a fire chief in Middletown, and many early victims were policemen, fireman, and retirement funds for first responders. The Saber Funds grew to have more than 200 investors from whom the defendant raised more than $10 million.

Falci falsely told investors that the Saber Funds were conservatively invested in tax liens - which generated high returns with little risk. In reality, Falci diverted investor money to himself, his family, and to other companies he controlled. Some of the diverted funds were used for riskier ventures, such as day trading and real estate. Falci concealed losses and his own theft from investors. Based on these misrepresentations, investors continued to entrust additional funds to Falci and left previous investments under his control.

In early 2012, Falci started the Vicor Fund, targeting wealthier investors with greater sophistication in financial affairs. The investors in the Vicor Fund included financial industry professionals, and Falci ultimately raised $20 million from these victims. He again falsely represented that he had experience and a track record of success investing in tax liens, and promised that he could produce high rates of return with little risk. In reality, the assets of the Vicor Fund were rapidly depleted by Falci's theft. 

In order to support his own lifestyle and repay investors the gains he had promised, Falci stole more than $10 million from the Vicor Fund between 2012 and 2016. At the same time, he reported fake investment gains to his investors on every monthly statement. Falci concealed his theft in several ways, including by diverting funds to a fake company that he created to steal from investors. He also forged emails and reports, and created fake assets for the fund.

SEC Obtains Final Judgment Against Howard M. Appel in Stock Manipulation Scheme (DOJ Release)
In a Complaint filed in the United States District Court for the Eastern District Of Pennsylvania, the SEC charged Howard M. Appel for his role in orchestrating schemes to manipulate the trading price of three microcap companies. The Court permanently enjoins Appel from violating the antifraud provisions of Sections 17(a)(1) and 17(a)(3) of the Securities Act and Section 10(b) of the Securities Exchange Act and Rules 10b-5(a) and 10b-5(c) thereunder, and the market manipulations provisions in Exchange Act Sections 9(a)(1) and 9(a)(2); and imposes permanent penny stock and officer-and director and bars, and awards $3,868,699 in disgorgement and $487,248 in pre-judgment interest. In a parallel criminal action, Appel was sentenced after his guilty plea to 60 months in prison and ordered to forfeit $3,868,699, and fined $200,000. The DOJ Release asserts in part that:

Appel and associates that he recruited and directed to buy and sell shares, secretly acquired ownership or control over enough of the companies' stock that he effectively controlled the float. Then he and his associates artificially created a market for these stocks by engaging in matched trading designed to create the false appearance of genuine demand for the stock. During and after his alleged manipulative conduct, Appel obtained over $3 million in profits by selling his shares in the companies into the public market. Appel was previously convicted of criminal conspiracy to commit securities fraud and was on probation when some of the charged conduct occurred.

SEC Charges Unregistered Broker Who Sold Woodbridge Securities to Retail Investors (SEC Release)
In a Complaint filed in the United States District Court for the Central District of California,, the SEC charged Charles Nilosek, an external sales agent for Woodbridge Group of Companies LLC, with  with violating the registrations provisions of Sections 5(a) and 5(c) of the Securities Act and Section 15(a)(1) of the Securities Exchange Act and seeks disgorgement of allegedly ill-gotten gains, with interest, and financial penalties. Previously, the SEC had charged Woodbridge Group, Robert H. Shapiro (the firm's former owner), two former directors of investments, and other unregistered brokers. In January 2019, a federal court in Florida ordered Woodbridge, related companies, and Shapiro together to pay $1 billion for operating a Ponzi scheme. As set forth in part in the SEC Release:

[F]rom at least September 2013 to September 2015, Nilosek and his alter-ego company, Position Benefits LLC, raised more than $23 million by selling Woodbridge securities to more than 200 retail investors located in at least four states. Nilosek was not registered in any capacity with the SEC, and allegedly received more than $1.4 million in transaction-based compensation. The SEC amended its Complaint in the Central District of California and added Nilosek as a defendant.

Sunsets, Russets, and Rule Resets (Speech by SEC Commissioner Hester Peirce; CARE Conference)
Among SEC Commissioner Peirce's various ruminations:

We also can do a better job of encouraging our examinations and enforcement staff, who have deep knowledge about what is going on in the industry, to flag for our rulemaking divisions rules that are in need of updating. Enforcement attorneys, for example, have frontline knowledge about how our transfer agent rules need to be updated and strengthened to better protect investors from fraud, and our compliance examiners routinely in the course of their work see the need for updates to our advertising and custody rules. If the only recognition staff receives is linked to enforcement actions, enforcement lawyers and compliance examiners are unlikely to be part of the agency's broader effort of identifying rules that need to be modernized. We need, therefore, to reward staff whose insights inform our rulemaking priorities, rather than simply counting the number of completed enforcement actions their work generates.