Securities Industry Commentator by Bill Singer Esq

August 2, 2019
In a Complaint filed in the United States District Court for the District of New Jersey, Jason M. Torres and Jordana Weber were each charged with one count of wire fraud conspiracy and one count of money laundering. As set forth in part in the DOJ Release:

Between April 2017 and the present, Torres, Weber, and others owned and operated several shell companies - one of which employed individuals who lived in New Jersey and performed work while in New Jersey - that falsely purported to offer lending services to customers, typically small business owners seeking high value loans, often in excess of $100 million. As part of the scheme, Torres, Weber and others required customers to pay up to 5 percent of a potential total loan amount as a "fee" prior to the loan being funded. 

After the victim's "fee" was paid, the defendants and others would engage in a fake "due diligence" period, during which they frequently gave victims bogus explanations for why the funding of their loan was delayed. It was also common to provide the victims with falsified or fraudulent documents, including bank statements that purported to show that the shell companies had sufficient money to fund the loan.  

Torres, Weber, and others used the "fees" paid by the victims for their daily living expenses, as well as for numerous lavish purchases, which included several luxury vehicles, high priced artwork, and vacations. The "fees" were also used to pay back previous victims of the fraud, in the manner of a traditional Ponzi scheme. To date, approximately six victims have been identified with a total of $7 million being transferred to bank accounts controlled by Torres, Weber, and others.

In a Complaint filed in the United States District Court for the District of Massachusetts, the SEC charged Commonwealth Equity Services, LLC d/b/a Commonwealth Financial Network with violating  the antifraud and compliance provisions of Section 206(2) and 206(4) of the Investment Advisers Act of 1940 and Rule 206(4)-7 thereunder. As set forth in part in the SEC Release:

[S]ince at least 2007, Commonwealth had a revenue sharing agreement with the broker it required most of its clients use for trades in their accounts.  Under that agreement, Commonwealth received a portion of the money that certain mutual fund companies paid to the broker to be able to sell their funds through the broker, if Commonwealth invested client assets in certain share classes of those funds.  Between July 2014 and December 2018, Commonwealth received over $100 million in revenue sharing from the broker related to client investments in certain share classes of "no transaction fee" and "transaction fee" mutual funds. The SEC's Complaint alleges that Commonwealth breached its fiduciary duty to its clients by failing to disclose the conflicts of interest created by its receipt of compensation through the revenue sharing agreement.  Specifically, the SEC's Complaint alleges that Commonwealth failed to tell its clients that (i) there were mutual fund share class investments that were less expensive to clients than some of the mutual fund share class investments that resulted in revenue sharing payments to Commonwealth, (ii) there were mutual fund investments that did not result in any revenue sharing payments to Commonwealth, and (iii) there were revenue sharing payments to Commonwealth under the broker's "transaction fee" program. As a result of these material omissions, Commonwealth's advisory clients invested without a full understanding of the firm's compensation motives and incentives.
Former registered investment adviser and Executive Compensation Planners, Inc. ("ECP") President Hector May pled guilty to an Information in the United States District Court for the Southern District of New York alleging one count each of conspiracy to commit wire fraud and investment adviser fraud, and he was sentenced to 13 years in prison plus was three years of supervised release, and he was ordered to pay $8,041,233 in restitution, and forfeit $11,452,185. Hector May's daughter and former ECP Comptroller, Vania May Bell, was indicted on one count each of conspiracy to commit wire fraud and wire fraud. Read the 
Hector May Information
Vania May Bell Indictment
As set forth in part in the DOJ Release:      

Since 1982, MAY was the president of ECP and provided financial advisory services to numerous clients.  Since 1994, MAY was a registered representative of a broker dealer ("Broker Dealer-1").  In its role as a broker dealer, Broker Dealer-1 facilitated the buying and selling of securities for clients of Broker Dealer-1's registered representatives, including clients of MAY.  To that end, Broker Dealer-1 and associated clearing firms maintained securities accounts for ECP's clients and, through those accounts, held ECP's clients' money, executed their securities trades, produced account statements reflecting activity in the clients' accounts, and forwarded these account statements to ECP's clients.

In order to obtain money from the Victims' securities accounts with Broker Dealer-1, MAY advised the Victims, among other things, that they should use money from those accounts to have ECP, rather than Broker Dealer-1, purchase bonds on their behalf.  He further represented that by purchasing bonds through ECP directly, the Victims could avoid transaction fees.  Because MAY lacked the authority to withdraw money directly from the Victims' accounts with Broker Dealer-1, he persuaded the Victims to withdraw the money themselves and to forward that money to an ECP "custodial" account (the "ECP Custodial Account"), so that he could use the money to purchase bonds on their behalf. 

With the assistance of BELL, MAY guided the Victims, first, to withdraw their money from their Broker Dealer-1 accounts, and second, to send that money to the ECP Custodial Account by wire transfer or check.  At times, MAY falsely represented that the funds being withdrawn from Victims' Broker Dealer-1 accounts were the proceeds of prior bond purchases MAY had made.  After the Victims sent their money to the ECP Custodial Account, MAY did not use the money to purchase bonds.  Instead, MAY and BELL spent the money on business expenses, personal expenses, and to make payments to certain Victims in order to perpetuate the scheme and conceal the fraud. 

Specifically, in some cases, MAY used Victims' funds to make purported bond interest payments to other Victims.  In other cases, MAY used Victims' funds to make payments to other Victims who wished to withdraw funds from their accounts.  MAY and BELL also created phony "consolidated" account statements that they issued through ECP and sent to the Victims.  These "consolidated" account statements purported to reflect the Victims' total portfolio balances and included the names of bonds MAY falsely represented that he purchased for the Victims and the amounts of interest the Victims were supposedly earning on the bonds.  In order to create the phony consolidated account statements, MAY provided BELL with bond names and false interest earnings, and BELL created ECP computerized account statements and distributed them to the Victims.

To keep track of the money that the co-conspirators were taking from the Victims, BELL processed the Victims' payments for the purported bonds, entered them in a computerized accounting program, and, through that program, kept track of how MAY and BELL received and spent the Victims' stolen money.  In this way, from the late 1990's through March 9, 2018, MAY and BELL induced Victims to forward them more than $11,400,000.

Fraudster Brought Back from Kenya to Face Jail Time for Stealing Almost $750,000 from UCSD through a Spear Phishing Campaign (DOJ Release)
Amil Hassan Raage pled guilty in the United States District Court for the Southern District of California to conspiracy to commit wire fraud in connection with his receipt of some $750,000 derived from spear-phising. As set forth in part in the DOJ Release:

On July 23, 2018, the University of California San Diego (UCSD) received a spear phishing email from a fraudulent Dell email account instructing UCSD to redirect its payments meant for Dell equipment and services to Raage's Wells Fargo bank account in Minnesota.  Believing that the email was from a legitimate Dell employee, UCSD followed the instructions and redirected payment.

The email actually originated from one of Raage's co-conspirators in Kenya. From August 8 through September 12, 2018, UCSD sent Raage 28 payments totaling $749,158.37.  Each time UCSD wired money to Raage's account, Raage would promptly withdraw the money or transfer it to another account.  When UCSD learned of the fraud, it halted payments.

UCSD was not alone. Raage and his co-conspirators perpetrated a similar scheme on another university, this one in Pennsylvania. Again, a co-conspirator in Kenya used a falsified Dell account to instruct the Pennsylvania university to redirect its Dell payments to a bank account in Minnesota again controlled by Raage. Over the month of January 2018, the Pennsylvania university wired six payments totaling $123,643.77 to Raage's bank account before the university was alerted to the fraud and stopped payments.

After the bank froze Raage's accounts, he fled to Kenya on September 22, 2018. Working with Kenyan law enforcement, the FBI's Legal Attache in Kenya, and the Department of Justice's Office of International Affairs, Kenyan police arrested Raage on May 7, 2019, and extradited back to the United States on May 23, 2019, to face prosecution for his involvement in this theft.

FINRA Bars Rep For Not Computing. In the Matter of Orlando Vargas, Respondent (FINRA AWC 2018057528501)
For the purpose of proposing a settlement of rule violations alleged by the Financial Industry Regulatory Authority ("FINRA"), without admitting or denying the findings, prior to a regulatory hearing, and without an adjudication of any issue, Orlando Vargas submitted a Letter of Acceptance, Waiver and Consent ("AWC"), which FINRA accepted. In accordance with the terms of the AWC, FINRA imposed upon Orlando Vargas a Bar from association with any FINRA member firm in any capacity. As set forth in part in the AWC:

Fidelity sponsored a program by which it reimbursed its employees for personal computer equipment purchases. Employees were required to purchase the computer equipment and submit receipts for reimbursement under the program. 

On May 20, 2016 and August 19, 2016, Vargas sought reimbursement under the program by submitting to Fidelity order information for computer equipment that he had not actually purchased. In fact, Vargas had canceled the orders before completing the purchase of the computer equipment. Through this conduct, Vargas falsely represented to Fidelity that he had purchased computer equipment, obtained $2,000 in reimbursement to which he was not entitled and thereby converted Firm funds. By converting Firm funds, Vargas violated FINRA Rule 2010. 

Vargas also provided false information to FINRA regarding his use of the Fidelity computer reimbursement program in written responses to FINRA Rule 8210 requests, and thereby violated FINRA Rules 8210 and 2010.
Of the 10 FINRA Hearing Officers, 7 had some FINRA employment prior to their hearing officer role. As to the remaining three previously-non-FINRA-affiliated Hearing Officers, each of them was employed by the SEC. Imagine if 7 of the Hearing Officers were former in-house counsel at Wells Fargo or JP Morgan, and the other 3 were former lawyers at major law firms representing financial services firms. In that latter scenario, PIABA and other public advocates would scream bloody murder -- and with justification.

FINRA Censures and Fines Firm Over Do Not Call List Bypasses. In the Matter of Dawson James Securities, Inc., Respondent (FINRA AWC 2018056290001)
For the purpose of proposing a settlement of rule violations alleged by the Financial Industry Regulatory Authority ("FINRA"), without admitting or denying the findings, prior to a regulatory hearing, and without an adjudication of any issue, Dawson James Securities, Inc. submitted a Letter of Acceptance, Waiver and Consent ("AWC") finding that the firm had violated FINRA Rules 3230 and 2010, which FINRA accepted. In accordance with the terms of the AWC, FINRA imposed upon Dawson James Securities a Censure and $20,000 fine. As set forth in part in the AWC:

[D]awson James required that its registered representatives use the Gryphon Network, which blocked calls to telephone numbers that appeared on the national DNC list and the firm's DNC list. Nevertheless, during the Relevant Period, registered representatives in Dawson James' New York branch office bypassed the Firm's Gryphon Network when they called at least 49 telephone numbers that appeared on the national DNC list and for which no exception applied. 
SEC Charges Brixmor Property Group Inc. and Former Senior Executives with Accounting Fraud (SEC Release)

In a Complaint filed in the United States District Court for the Southern District, the SEC charged Brixmor Property Group, Inc.'s CEO Michael Carroll, CFO Michael Pappagallo, CAO Steven Splain and Senior VP of Accounting Michael Mortimer with violating or aiding and abetting violations of the antifraud and books and records provisions of the Securities Exchange Act, as well as with violating Rule 100(b) of Regulation G, which pertains to the reporting of non-GAAP performance measures. Splain and Mortimer agreed to the entry of partial judgments against them in which they consent to injunctive relief with other monetary relief and bars to be determined by the Court. Without admitting or denying the allegations, Brixmor consented to findings in an SEC Order that the company violated the antifraud provision of the federal securities laws and Rule 100(b) of Regulation G, and filed false and misleading annual, quarterly, and current reports with the SEC. Brixmor agreed to pay a $7 million penalty and comply with certain undertakings, including retaining an independent consultant to review and assess controls relating to the calculation and presentation of non-GAAP measures including SP NOI. In a parallel action, the U.S. Attorney's Office for the Southern District of New York today announced criminal charges against Carroll, Pappagallo, Splain, and Mortimer. Splain and Mortimer have pleaded guilty to those charges.As set forth in part in the SEC Release:

[F]rom the third quarter of 2013 to the third quarter of 2015, Brixmor CEO Michael Carroll, CFO Michael Pappagallo, CAO Steven Splain and Senior VP of Accounting Michael Mortimer improperly adjusted Brixmor's same property net operating income (SP NOI) in order to report quarterly numbers that hit the Company's publicly-issued growth targets. According to the complaint, certain of the defendants described their manipulation of the non-GAAP measure as "mak[ing] the sausage," using tactics such as selectively recognizing income from a "cookie jar" account, incorporating certain income that the company had represented was excluded, and improperly lowering the prior year's SP NOI to give the appearance of stronger growth in the current year.

In an Indictment filed in the United States District Court for the Southern District of New York, Carroll and Pappagallo were each charged with conspiracy to commit securities fraud and other offenses (Count One), securities fraud (Count Two), making false statements in filings with the SEC (Counts Three and Four); and filing false certifications (Counts Five and Six).  Splain pled guilty to one count of conspiracy to commit securities fraud and to making false filings with the SEC, and one count of securities fraud. Mortimer pled guilty to one count of conspiracy to commit securities fraud and to make false filings with the SEC, and one count of securities fraud. As set forth in part in the DOJ Release:

CARROLL, PAPPAGALLO, Splain, and Mortimer engaged in this manipulation of SS-NOI Growth through three primary means.  First, in quarters in which Brixmor generated more than enough income to meet the bottom, or in some cases middle, of its guidance range, it illicitly "stored" reportable income instead of immediately recognizing it, a deceptive practice often referred to as "cookie jar" accounting.  In fact, certain Brixmor employees frequently referred to a particular account that was used to hold such income as the "cookie jar."  Brixmor employees then utilized that income in later quarters as necessary to inflate SS-NOI Growth in order to report the desired steady and smooth SS-NOI Growth to the investing public.  For example, on April 6, 2015, PAPPAGALLO emailed Splain, Mortimer, and others to schedule a meeting "regarding same property NOI planning" the "objective" of which was "to try to make decisions on 1Q number - push a little or squirrel away stuff for 2Q & 3Q." 

Second, Brixmor reported in all of its public filings that it did not take lease termination income ("LSI") into account when calculating SS-NOI.  LSI is money that a tenant pays as a lump sum payment upon the early termination of a lease.  Notwithstanding these representations, CARROLL, PAPPAGALLO, Splain, and Mortimer included some portion of LSI within SS-NOI when doing so helped show steady SS-NOI Growth or to meet guidance. 

Third, CARROLL, PAPPAGALLO, Splain, and Mortimer at times removed payments that had been included in SS-NOI in a prior Comparison Period in order to the boost SS-NOI Growth for the current period.  Because SS-NOI Growth effectively measures the SS-NOI change from one period to another, retroactively reducing the SS-NOI for a prior Comparison Period has the effect of creating a bigger spread to SS-NOI in the current period, thereby increasing the SS-NOI Growth metric for the current period.  For example, after the close of the third quarter of 2015 but before reporting SS-NOI Growth for that period, CARROLL instructed certain Brixmor employees as to what SS-NOI Growth figures he wanted the company to show for the third and fourth quarters of the year.  CARROLL, PAPPAGALLO, Splain, Mortimer, and others then went to work manipulating Brixmor's SS-NOI Growth number for the third quarter, including by making multiple changes to the Comparison Period, in order to report the SS-NOI Growth number that had been pre-determined by CARROLL - a number that showed consistent growth over the year and was within guidance.  Toward the end of these discussions, on October 6, 2015, PAPPAGALLO sent an email to Splain and Mortimer, stating "[Splain] and [Mortimer] LLC Bratwurst at its Finest," to which Mortimer responded with an image of a man holding a batch of sausage.

As a result of these manipulations, Brixmor reported steady quarter-by-quarter SS-NOI Growth between 2013 and 2015 that consistently fell within the company's public annual guidance. . .

Renegade Pandas: Opportunities for Cross Border Cooperation in Regulation of Digital Assets (Speech by SEC  Commissioner Hester Peirce at the Singapore University of Social Sciences Convergence Forum)
In part, Commissioner Peirce observes that [Ed: footnotes omitted]:

As I have expressed elsewhere, I would like to see more focused momentum at the U.S. SEC toward finalizing our regulatory regime for digital assets. We have not been sitting idle, however, and I would like to take a few minutes now to outline the steps we have taken. The most basic, but essential, of these steps is our efforts to understand digital asset technology and markets. We established a Strategic Hub for Innovation and Financial Technology, known as FinHub, which coordinates our approach to digital assets. FinHub staff have met with hundreds of market participants to hear what they are working on and where they need regulatory clarity. At the end of May, FinHub held a one-day FinTech Forum to consider issues arising in several key areas of securities law: capital formation, secondary trading and markets, and investment management. The participants explored and provided us with market insight into how initial coin offerings (ICOs) proceed, what issues auditors face in auditing digital assets, how brokers can think about custody, and what investors might consider in deciding to buy digital assets.

One of the peculiarities of the U.S. system is the sheer number of regulators. Not only do we have the state-federal allocation of responsibility that I just mentioned, but we have multiple federal financial regulators. The SEC regulates only securities; other agencies regulate commodities, currencies, many derivatives, and bank products. Even the federal securities space is shared with a quasi-private regulator, the Financial Industry Regulatory Authority (FINRA), which regulates broker-dealers, and with other non-governmental regulators.

Another notable feature of U.S. law is that the definition of what constitutes a security is a bit nebulous. Unlike many other countries, we do not have an exclusive list of what counts as a "security." The term of course includes stock, bonds, debentures, notes, puts, calls, and other classic "security" instruments, but it also includes "investment contracts." The courts have defined the investment contract category of securities by considering whether it encompasses particular assets presented in litigation. In the grandfather of these cases, SEC v. Howey, our Supreme Court established a test for determining whether something was an investment contract and therefore a security under our laws. Howey involved interests in an orange grove, so it is clear that an instrument need not look, smell, or taste like a traditional security in order to be deemed one by our laws. Under Howey, something-including something that is a digital asset-is a security if it involves an investment in a common enterprise with an expectation of profits derived solely through the efforts of others.