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Enforcement News: SEC Settles Enforcement Actions that Underscore the Importance of a Robust Regulatory Disclosure Scheme

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  • Posted on: Jul 17 2019

The disclosure of material information is the foundation of the Securities and Exchange Commission’s (“SEC”) mission. For this reason, the SEC considers itself to be “a disclosure agency.” See “The Importance of the SEC Disclosure Regime” by Daniel M. Gallagher, Commissioner, U.S. Securities and Exchange Commission (July 16, 2013) (here). One need only look at the SEC’s website to confirm this point: “[t]he laws and rules that govern the securities industry in the United States derive from a simple and straightforward concept: all investors, whether large institutions or private individuals, should have access to certain basic facts about an investment prior to buying it, and so long as they hold it.” (Here.) To further underscore the point, Commissioner Gallagher said the following in his post:

The federal corporate disclosure regime was established by Congress and serves as a cornerstone of the Commission’s tripartite mission to protect investors, maintain fair, orderly, and efficient markets, and facilitate capital formation. The underlying premise of the Commission’s disclosure regime is that if investors have the appropriate information, they can make rational and informed investment decisions. This is not to say that the disclosure regime was meant to guarantee that investors receive all information known to a public company, much less to eliminate all risk from investing in that company. Instead, the point has always been to ensure that they have access to material investment information.

The foregoing themes were recently highlighted in a speech given by William H. Hinman, Director of the Division of Corporation Finance, at the 18th Annual Institute on Securities Regulation in Europe on March 15, 2019:

As you know, our disclosure requirements are intended to provide investors with the material information they need about companies and their securities offerings to make informed investment and voting decisions. Robust disclosure decreases information asymmetries and is the foundation of reliable price discovery. When investors have confidence that they are receiving full and transparent disclosure, markets operate more efficiently and the cost of capital is reduced.

With the foregoing in mind, this Blog looks at three enforcement proceedings brought by the SEC against individuals and entities that failed to disclose material information to their investors, customers, and/or shareholders.

In the Matter of Fieldstone Financial Management Group, LLC et al.

On July 1, 2019, the SEC announced (here) that it charged Fieldstone Financial Management Group LLC (“Fieldstone”) and its principal, Kristofor R. Behn (“Behn”), both of Foxboro, Massachusetts, with defrauding retail investment advisory clients by failing to disclose conflicts of interest related to their recommendations to invest in securities issued by affiliates of Oregon-based Aequitas Management LLC (“Aequitas”).  The SEC also accused Behn of misusing an investor’s funds to pay personal expenses.

According to the SEC (here), from 2014 to early 2016, approximately 40 retail clients of Behn and Fieldstone invested more than $7 million in Aequitas securities, which were the subject of a previous Commission enforcement action.  The SEC found that Behn and Fieldstone failed to disclose to their clients that Aequitas had provided Fieldstone with a $1.5 million loan and access to a $2 million line of credit, both of which had terms that created a significant financial incentive for Behn and Fieldstone to recommend Aequitas securities to their clients.  The SEC further found that Behn and Fieldstone made material misstatements and omissions in reports filed with the Commission, including false representations that the repayment terms of the loan from Aequitas were not contingent on Fieldstone clients investing in Aequitas.

In addition, the SEC found that Behn and Fieldstone fraudulently induced a client to invest $1 million in Fieldstone.  Within days of Fieldstone receiving the $1 million, Behn used approximately $500,000 to pay his personal taxes and make other payments to himself or for his personal benefit.

“Behn flagrantly disregarded his most basic duties as an investment adviser by concealing the significant financial incentives he and his firm would receive by recommending investments in Aequitas,” said Erin E. Schneider, Director of the SEC’s San Francisco Regional Office.  “The Commission is committed to rooting out breaches of fiduciary duty to retail investors.”

[Ed. Note: This Blog previously discussed the triad fiduciary duties (i.e., candor, loyalty and due care) here.]

Without admitting or denying the SEC’s findings, Fieldstone and Behn consented to the issuance of the order, which found that they violated the antifraud provisions of the federal securities laws, censured Fieldstone, ordered them to cease and desist from future violations, and ordered them to pay, on a joint-and-several basis, disgorgement and prejudgment interest of $1,047,971 and a penalty of $275,000, all of which is to be distributed to investors harmed by the alleged wrongdoing.  Behn will also be permanently barred from association with any broker, dealer, investment adviser, municipal securities dealer, municipal advisor, transfer agent, or nationally recognized statistical rating organization.

In the Matter of Nomura Securities International, Inc.

On July 15, 2019, the SEC announced that it had instituted two related enforcement actions against Nomura Securities International, Inc. (“Nomura”), which agreed to repay approximately $25 million to customers for its failure to adequately supervise traders in mortgage-backed securities.

In its orders (here and here), the SEC found that Nomura bond traders made false and misleading statements to customers while negotiating sales of commercial and residential mortgage-backed securities (“CMBS” and “RMBS”).  According to the SEC, several Nomura traders misled customers about the prices at which Nomura had bought securities, the amount of profit Nomura would receive on the customers’ potential trades, and who currently owned the securities, with traders often pretending that they were still negotiating with a third-party seller when Nomura had, in fact, already bought a security.  The SEC further found that Nomura lacked compliance and surveillance procedures that were reasonably designed to prevent and detect this alleged misconduct, which inflated the firm’s profits on CMBS and RMBS transactions at its customers’ expense.  The SEC previously filed charges against two CMBS and three RMBS traders at Nomura, whose misrepresentations were described in the SEC’s orders.

“Firms acting as dealers in opaque markets like those for CMBS and RMBS must take steps to prevent misleading communications with their customers,” said Daniel Michael, Chief of the SEC Enforcement Division’s Complex Financial Instruments Unit.

“These orders underscore that firms must have adequate supervisory procedures, particularly surrounding the sale of complex instruments,” said Sanjay Wadhwa, Senior Associate Director of the SEC’s New York Regional Office.  “Weak procedures, such as those found here, may enable employee misconduct to go undetected.”

To settle the charges that it failed to reasonably supervise its traders, Nomura agreed in the two orders to be censured and to reimburse customers the full amount of firm profits earned on any RMBS or CMBS trades in which a misrepresentation was identified, paying over $20.7 million to RMBS customers and over $4.2 million to CMBS customers.  Nomura also agreed to pay a $1 million penalty in the RMBS-related case and a $500,000 penalty in the CMBS-related case.  Both orders noted that the penalty amounts reflected substantial cooperation by Nomura during the SEC’s investigation, including remedial efforts by the firm to improve its surveillance procedures and other internal controls.

SEC v. AR Capital, LLC

On July 16, 2019, the SEC announced (here) that it had charged AR Capital LLC (“AR Capital”), its founder Nicholas S. Schorsch (“Schorsch”), and its former Chief Financial Officer, Brian Block (“Block”), with wrongfully obtaining millions of dollars in connection with two separate mergers between real estate investment trusts (“REITs”) that were sponsored and externally managed by AR Capital. The defendants agreed to settle the matter by, among other things, agreeing to over $60 million in disgorgement, prejudgment interest and civil penalties.

According to the SEC’s complaint (here), between late 2012 and early 2014, AR Capital arranged for American Realty Capital Properties Inc. (“ARCP”), a publicly-traded REIT, to merge with two publicly-held, non-traded REITs. The SEC alleged that AR Capital, Schorsch, and Block, acting in breach of the relevant proxy disclosures, inflated an incentive fee in both mergers. As alleged, this improper calculation allowed them to obtain approximately 2.92 million additional ARCP operating partnership units as part of their incentive-based compensation. In addition, the SEC alleged that the defendants wrongfully obtained at least $7.27 million in unsupported charges from asset purchase and sale agreements entered into in connection with the mergers.

“REIT managers and their professionals have an obligation to tell the truth when making disclosures to shareholders about their compensation,” said Marc P. Berger, Director of the SEC’s New York Regional Office. “As we allege in our complaint, AR Capital and its partners Schorsch and Block failed to do so and benefitted themselves greatly at the expense of shareholders.”

The SEC’s complaint, filed in the United States District Court for the Southern District of New York, charged AR Capital and Block with violating the antifraud provisions of Section 17(a) of the Securities Act of 1933 and Section 10(b) of the Securities Exchange Act of 1934 and Rule 10b-5(b) promulgated thereunder, and falsifying books and records of ARCP. The complaint charged Schorsch with negligently violating the antifraud provisions of Sections 17(a)(2) and (3) of the Securities Act of 1933, as well as books and records violations.

Without admitting or denying the allegations in the complaint, AR Capital, Schorsch, and Block consented to entry of a final judgment that imposed permanent injunctions from violations of the charged provisions; ordered combined disgorgement and prejudgment interest on a joint-and-several basis of over $39 million, which included cash and the return of the wrongfully obtained ARCP operating partnership units; and imposed civil penalties of $14 million against AR Capital, $7 million against Schorsch, and $750,000 against Block. The settlements are subject to court approval.

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