By Ali Levenson

On December 16, 2014, the U.S. Securities and Exchange Commission (SEC) suspended trading of securities of Las Vegas electronic cigarette company American Heritage International, Inc. (“AHII”). The SEC cited to concerns regarding potentially manipulative activity related to AHII common stock. The “potentially manipulative activity” was prompted by a series of unsolicited “robo” calls regarding the company’s common stock. Traditionally, these types of unsolicited calls have been associated with “pump-and-dump” schemes.

Pump-and-dump schemes lure investors with aggressive and optimistic statements about the company through promotions intended to create demand for the shares, causing share price and volume to spike. Once share price and volume are high, those behind the scam sell off their shares at a profit and stop promoting the stock, causing share prices to fall, leaving those who invested with near-worthless stock. AHII, however, released a press release in response to the temporary suspension stating the company had nothing to do with the calls, that management did not sell any of its shares, and that it intends to fully cooperate with the SEC investigation.

The AHII temporary suspension comes as the newest mechanism for “pump and dumps” schemes, which have become increasingly used to induce investments in “hot” stocks. In January 2014, the SEC similarly temporarily suspended trading for numerous marijuana-related companies, and as a result, the Financial Industry Regulatory Authority (FINRA) issued two Investor Alerts to warn the public about the increased potential for these types of investment scams. Pump-and-dump scammers usually generate hype around a “hot” or popular topic. Recent scams include marijuana stocks, e-cigarette companies, and even companies purporting to be developing Ebola treatments.

As a result of fraudsters increasingly using prominently featured news stories to turn a profit, both FINRA and the SEC’s Office of Investor Education and Advocacy publish Investor Alerts to equip investors with tools to aid in avoiding the scams. The alerts list tips for investors to avoid these types of scams. FINRA offers two free online tools to educate investors on spotting and avoiding investment scams, the Scam Meter and Risk Meter. The Scam Meter asks investors questions regarding the nature of the investment and generates “red flags” to help identify potential scams. The Risk Meter compares investors’ responses to two research studies that examined the differences between known investment fraud victims and non-victims. Based on the investors’ responses to the questions, the tool places the investor in a colored “zone” (red, yellow, or green) indicating the degree to which the investor’s responses correspond with known instances of investment fraud. These two tools can provide investors unbiased insight when determining whether any investment opportunity sounds too good to be true.

Education and research seem to be the best defense against falling victim to these types of investment fraud schemes. By reading SEC and FINRA alerts and by using FINRA’s online tools, investors can be more confident in the quality of their investment choices and be less likely to fall victim to fraudsters using the latest news story to generate hype and fund scams.

By Amanda E. Preston

Casting a blind eye may help executives sleep better at night, but it may also cost them half a million dollars. On February 10, 2015, the Securities and Exchange Commission (SEC) announced that it had entered into a settlement with William Slater and Peter Williams III, two former chief financial officers of Saba Software, Inc. (Saba). Slater and Williams agreed to return $336,375 and $141,992, respectively,  in bonuses and stock sale profits they received while the Silicon Valley software company was committing accounting fraud. Last year, the SEC worked out a similar settlement with former Chief Executive Office Babak “Bobby” Yazdani, in which he agreed to hand back $2.5 million.

While Slater, Williams, and Yazdani were not personally charged with the company’s misconduct, Section 304 of the Sarbanes-Oxley Act still requires the executives to reimburse the company for monetary perks received during the commission of the fraud. Saba was discovered to have filed financial statements which overstated its pre-tax earnings and misrepresented its revenue recognition practices. Specific allegations included claims that the company’s professional-services managers directed consultants in its Indian subsidiary to fabricate time records in order to meet quarterly revenue and margin goals.

The SEC’s clawback provision, expanded by Section 954 of the Dodd-Frank Act, applies to current and former executive officers, and is triggered by any accounting restatement due to material non-compliance with financial reporting laws. The provision allows the SEC to pursue the recovery of incentive compensation greater than what would have been paid to the officer under the accounting restatement. The SEC first exercised this new clawback authority in July 2009 when it went after the former CEO of CSK Auto Corporation. The case, SEC v. Jenkins, settled for $2.8 million.

Lawyers for Slater expressed their regret at the SEC’s decision to clawback profits from the Saba executives, claiming that his lack of knowledge about the company’s misconduct, and the SEC’s failure to allege any wrongdoing on his part, made “the demand for disgorgement . . . unjust.” But the SEC doesn’t see it that way, stating that even the innocent executive has “an obligation to return their bonuses and stock sale profits to the company for the benefit of the shareholders who were misled.”

By George Pita

On September 30, 2014, The Securities and Exchange Commission (“SEC”) filed a civil injunctive action against Positron Corporation (“Positron), a microcap company based in Illinois, Patrick G. Rooney, the company’s then-CEO, and John R. Rooney of Jupiter, Florida. The SEC charged the three with masterminding a manipulation scheme involving the company’s stock.

Positron is a self-described nuclear medicine company, which reported $1.6 million dollars in revenue in 2013, but lost $7.1 million. Positron’s shares are currently trading at less than a penny.

The SEC alleged that through several meetings that took place in Palm Beach, the Rooney brothers hired stock promoters to inflate shares of the lightly traded company by purchasing them on the open market. Fortunately for the public, and unfortunately for the Rooney brothers, these stock promoters were cooperating with the FBI. According to the complaint, John Rooney ordered the stock promoters to purchase 20,000 shares of Positron on the open market in exchange for a cash payment of $4,000. He also gave them advance copies of Positron press releases so they could coordinate their purchases to look like the market reacted positively to them.

In August 2012, the FBI, through its cooperating stock promoters, purchased shares of Positron after receiving instructions from Patrick Rooney. Mr. Rooney paid the stock promoters only $1,000 of the agreed-upon $4,000 bribe. The SEC asked that the court penalize the Rooney brothers with civil fines, a bar against participating in penny stock offerings, and a bar against Patrick Rooney serving as an officer or director of a public company.

The Rooney Brothers are notorious to the SEC. In July of this year, the United States District Court for the Northern District of Illinois entered a judgment imposing $715,700 in disgorgement, plus prejudgment interest of $166,476 against Patrick Rooney. In Securities and Exchange Commission v. Patrick G. Rooney and Solaris Management, LLC, the SEC alleged that Rooney and Solaris radically changed the investment strategy of the Solaris Opportunity Fund LP (“Solaris Fund”), contrary to Solaris Fund’s offering documents and marketing materials, by becoming wholly invested in Positron, the company whose stock Mr. Rooney allegedly attempted to manipulate.

The SEC further alleged that Patrick Rooney, who had been chairman of Positron since 2004 and received salary and stock options from Positron since September 2005, misused the Solaris Fund’s money by investing more than $3.6 million in Positron through private transactions and market purchases. Many of these private transactions were undocumented while other investments were interest-free loans to Positron. Rooney and his compatriots hid the Positron investments and Rooney’s relationship with the company from the Solaris fund’s investors for over four years. Although Rooney finally told investors about the Positron investments in a March 2009 newsletter, the SEC’s complaint alleges he falsely told them he became chairman to safeguard Solaris Fund’s investments, while in reality these investments benefited Positron and Rooney while providing Solaris Fund with a concentrated, undiversified, and illiquid position in a cash-poor company with a lengthy track record of losses.

The actions of the Rooney brothers illustrate the need for investors to be cautious in investing in highly risky stock. While the SEC and law enforcement are working diligently to prevent stock manipulation schemes from taking place, the first line of defense against them is diligence and caution. It is important that you perform your own investigation into any stocks that a broker recommends, and it is important to review your broker’s reputation before entering into business with them.

By Nathaniel Touboul

The financial crisis of 2008 led regulators to the realization that municipalities needed a system that protects their own interests when dealing with Wall Street. To achieve this goal, the Dodd-Frank Act, among other things, created a new class of regulated persons called “Municipal Advisors” (MAs). Under new regulations, MAs may not provide advice on behalf of, or to municipal entities without first registering with the Securities and Exchange Commission (SEC). MAs will also be held to a fiduciary standard. These new regulations are aimed at issues regarding MA misconduct such as “pay to play” practices, undisclosed conflicts of interest, advice rendered without adequate qualifications and failure to place their duty of loyalty to their clients ahead of their own interests.

Ultimately, the goal is to protect the investor and the integrity of the market. The Municipal Advisor Examination Initiative (“MA Examination Initiative”) will provide the SEC with valuable information that will allow it to discover new areas of potential MA abuse. Also, the new registration process will create a direct link between MAs and the SEC, thereby facilitating oversight.

It is often the case that when an advisor orchestrates a transaction for a municipality, the advisor will provide advice and counsel to the municipality as well. The issue with this system is that not all underwriters and brokers are fair. An example of this misconduct occurred in 2008 in Jefferson County, Alabama, where a J.P Morgan Chase banker led officials into entering a complicated interest rate swap deal. Although the banker and some county officials later pleaded guilty to corruption charges related to the deal, it eventually led Jefferson County into bankruptcy in 2011.

From the investor’s perspective, scenarios such as Jefferson County’s bankruptcy show that even investments that have traditionally been viewed as “safe” such as municipal bonds are not immune from disasters. Even when making “safe” investments, it is important for investors to understand the potential risks, including the risks of a municipality defaulting on its debt obligations. These new regulations will create more oversight and facilitate compliance with new regulations designed to prevent the kind of misconduct that led to the Jefferson County bankruptcy.

To respond to situations such as the one that occurred in Jefferson County, the SEC announced that the Office of Compliance Inspections and Examinations (“OCIE”) is launching an examination initiative directed at newly regulated MAs. The OCIE examines MAs through the National Exam Program (NEP), which is comprised of staff of the SEC’s 11 regional offices and the home office in Washington, D.C. The NEP’s mission is to “protect investors and maintain market integrity through risk-focused examinations that promote compliance, prevent fraud, monitor risk and inform policy.” Through launching the MA Examination Initiative, the NEP will be able to conduct focused, risk-based examinations of MAs that are registered with the SEC, but not registered with FINRA. The MA Examination Initiative will be conducted over the next two years and will have three primary phases described as follows:

Engagement Phase:

This initial phase consists of outreach programs aimed at informing newly registered firms about their obligations under the Dodd-Frank Act and the MA Examination Initiative. This phase will also provide a forum for MA senior executives or principals to discuss issues, ask questions and communicate directly with the administrative agencies.

Examination Phase:

During this phase, the NEP staff will review the MAs selected for examination, and will determine whether they are in compliance with all applicable rules. The OCIE will focus on the following areas of identified risks:

1) Registration

2) Fiduciary Duty

3) Disclosure

4) Fair Dealing

5) Supervision

6) Books and Records

7) Training/Qualifications

Informing Policy Phase:

This final phase will consist of a final report from the NEP to the SEC containing common practices in the areas identified in the Examination phase, industry trends and other issues.

By Edel Gonzalez

Illegal insider trading has undermined the trust that investors have in the securities market for many years. It cripples public confidence in the market and hinders growth for investors and companies. In response, the Securities and Exchange Commission (SEC) has strengthened its commitment of investigating and prosecuting insider trading.

The SEC has defined illegal insider trading and what is considered permissive insider trading practices. According to the SEC, illegal insider trading is buying and/or selling a security in breach of a trust relationship and while in possession of nonpublic information, in violation of a fiduciary duty to keep such information confidential. Insider trading is permitted in certain circumstances such as when corporate insiders trade their own securities and report their transactions to the SEC.

The SEC has adopted rules to discourage and prevent such inappropriate behavior.  Rule 10b5-1 addresses the knowledge of a trader who is privy to material nonpublic information. Rule 10b5-2 states that a person receiving confidential information through non-business relationships owes a duty of confidentiality and may be found liable for violation of the duty.

The SEC has brought actions under these rules against corporate officers, government employees, friends and business associates of corporate employees, employees of law, and banking and brokerage firms with access to confidential trade information.

Just last month, the SEC charged Michael Anthony Dupre Lucarelli, a director of market intelligence at Manhattan’s Lippert/Heilshorn Investor Relations, with executing trades based on information he obtained through accessing client’s press releases from his firm’s computer network. Sanjay Wadhwa, senior director of the SEC’s New York Regional Office, commented on the investigation stating that Lucarelli knew that he was prohibited from using this information in order to gain advantage over other investors.

Lucarelli has been accused of intentionally falsifying his employment information on brokerage firms’ trading account applications in order to execute these illicit trades. The U.S. Attorney’s Office for the Southern District of New York has announced criminal charges against Lucarelli.

Cases such as Lucarelli’s pose questions as to whether these are isolated incidents in a mostly well regulated and good faith market or whether these are prevalent violations which require stronger reaction.

By Rachael Williams

In July 2013, the Securities and Exchange Commission (SEC) adopted the “Bad Actor” rule. This rule prevents companies and individuals with a “criminal conviction, regulatory or court order or other disqualifying event” from participating in private offerings and selling investments in hedge-funds or private-equity funds to clients. The rule is part of the 2010 Dodd-Frank regulation but ultimately went into effect in September 2013.

Citigroup’s disqualifying event stems from a 2007 mortgage-backed securities fraud complaint with the SEC that resulted in more than $700 million of losses to investors. Citigroup reached a $285 million settlement with the SEC on August 5, 2014, making it subject to the change in the law. Had Judge Jed Rakoff approved the original settlement offer back in November 2011, Citigroup would not have been subject to the rule. Judge Rakoff originally rejected the offer because he felt the fine was not large enough and disagreed with the SEC not requiring Citigroup to admit wrongdoing as part of the settlement. An appellate court ultimately found he had overstepped his reach, and the settlement was entered nearly three years later in August 2014.

Citigroup remains able to sell private investments to large institutions. However, selling private hedge-funds to wealthy individual clients has become a huge growth area for private banks and financial firms, as increasingly more investors are drawn to alternative investments. Citigroup was forced to send letters to hedge-fund firms informing them that the bank would no longer be able to steer clients to the firms’ hedge-funds. Previously, Citigroup offered approximately 40 hedge-funds to its wealthy clients, who were required to have a net worth of at least $25 million to invest. Citigroup subsequently stands to lose revenue generated from the fees the bank earned for every client placed in a private fund.

Despite the settlement, the bank will attempt to secure a waiver from the SEC to allow it to continue to conduct normal business. The SEC has the option to grant a waiver to certain “bad-actors” if it is in the public interest to do so. Citigroup will likely argue that its sale of private hedge-funds to its clients bears little to no relation to the acts for which it was found in violation of the law. While Citigroup’s sale of mortgage-linked security debt was the basis for settlement, the SEC’s choice to target Citigroup’s sale of hedge-funds demonstrates the trend of increased governmental oversight in this area.

The Volcker Rule provides additional oversight by restricting the profitability of banks through the sale of hedge-funds. Banks may now only invest 3% of Tier 1 capital in hedge or private-equity funds and cannot own more than 3% of any hedge-fund. Subsequently, banks such as Citigroup have begun spinning off internal hedge-fund units and private-equity funds in order to comply with the rule. The “Bad Actor” rule and Volcker rule will continue to have a major impact on the profitability of banks, as banks are increasingly restricted from reaping the benefits of growth in their clients’ hedge-fund and private-equity investments.

By Nathaniel Griffin

On June 3, 2014, the Securities Exchange Commission (“SEC”) petitioned for an emergency injunction preventing Albany, NY-based Scott Valente and The ELIV Group, LLC. (“ELIV”) from engaging in fraudulent securities trading. In its complaint, the SEC alleges misappropriation of customer funds and misrepresentations of customer account performance, investment guarantees, account values under management, and broker and firm qualifications.

ELIV Group claims to be an accredited organization; however, the firm is not registered with The Financial Industry Regulatory Authority “FINRA,” nor is Valente. In 2009 Valente was barred from associating with any FINRA members. This ban came after more than twenty customer disputes and other regulatory investigations by FINRA.

ELIV solicited customers through internet advertisements and investment seminars, claiming gains of over 34% for its managed customer accounts. The SEC alleges in its complaint that the customer accounts of over 80 persons were commingled within one account totaling over $8.8 million in initial investments, and that these funds have not seen gains, but have instead suffered dramatic losses. Further, the SEC claims that Valente made monthly and annual reports falsely stating the values of customer accounts and misrepresenting significant gains to his customers.

ELIV allegedly made numerous unauthorized withdrawals from customer funds for his personal use. In the customer agreements, Valente was entitled to 1% of the assets under management as his management fee. However, the total of the allegedly unauthorized withdrawals far exceeded that amount.

The sales tactics used by Valente are not at all uncommon, including in South Florida. According to the Financial Industry Regulatory Authority, approximately half of all investment seminars examined offered literature with exaggerated, misleading, or otherwise unwarranted information and 12% of seminars appeared to involve fraud.

For more information on advertising awareness, see FINRA’s Investor Alert: “Free Lunch” Investment Seminars—Avoiding the Heartburn of a Hard Sell.