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SEC Enforcement News: Elon Musk, Retail Brokers and Investment Advisors

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  • Posted on: Oct 8 2018

The Securities and Exchange Commission (“SEC” or “Commission”) ended the Government’s fiscal year with a flurry of proceedings and settled actions.  In addition to the settled actions against Tesla Inc. and Elon Musk, the SEC filed or settled matters against retail brokers and investment advisors for violations of the securities laws and the rules promulgated thereunder. In today’s post, this Blog looks at some of these actions.

Disclosure violations:

On September 29, 2018, the SEC announced (here) that Elon Musk (“Musk”), CEO and Chairman of Tesla Inc. (“Tesla”), and the company, agreed to settle a securities fraud charge that the SEC brought against each of them relating to Musk’s recent tweet about taking Tesla private.  The settlements, which are subject to court approval, require comprehensive corporate governance and other reforms — including Musk’s removal as Chairman of the Board — and the payment by Musk and Tesla of financial penalties.

The action arose from an August 7, 2018 tweet that Musk sent to followers wherein he said that he could take Tesla private at $420 per share — a substantial premium to its trading price at the time — that funding for the transaction had been secured, and that the only remaining uncertainty was a shareholder vote.

In a November 5, 2013 filing, Tesla stated that it intended to use Musk’s Twitter account as a vehicle to disseminate information about the company to the public. Since that date, Musk has repeatedly used his Twitter account to disseminate material information, such as financial guidance about the company, to the public. Over 22 million people follow Musk’s Twitter feed.

The SEC alleged that, in truth, Musk knew that the potential transaction he Tweeted about was uncertain and subject to numerous contingencies.  (A copy of the SEC’s complaint can be found here.) Musk had not discussed specific deal terms, including price, with any potential financing partners, and his statements about the possible transaction lacked an adequate basis in fact.  According to the SEC, Musk’s misleading tweet caused Tesla’s stock price to increase by over six percent on August 7 and led to significant market disruption.

The SEC noted that while Tesla’s Investor Relations Director responded to some inquiries about Musk’s tweet, he was not prepared to field the avalanche of questions that followed. According to the SEC, Musk “did not routinely consult with anyone at Tesla before publishing Tesla related information via his Twitter account.” In fact, the company “did not have processes in place to ensure that the information published was accurate and complete,” said the Commission.

Consequently, the SEC charged Tesla with failing to maintain adequate disclosure controls and procedures. According to the SEC’s complaint against Tesla (here), despite notifying the market in 2013 that it intended to use Musk’s Twitter account as a means of announcing material information about Tesla and encouraging investors to review Musk’s tweets, Tesla had no disclosure controls or procedures in place to determine whether Musk’s tweets contained information required to be disclosed in Tesla’s SEC filings.  Nor did it have sufficient processes in place to ensure that Musk’s tweets were accurate or complete.

Musk and Tesla agreed to settle the charges against them without admitting or denying the SEC’s allegations.  Among other relief, the settlements require: Musk to step down as Tesla’s Chairman and be replaced by an independent Chairman; Musk to be ineligible for re-election as Chairman for three years; Tesla to appoint two new independent directors to its board; Tesla to establish a new committee of independent directors and put in place additional controls and procedures to oversee Musk’s communications; and Musk and Tesla to each pay a separate $20 million penalty. The SEC will distribute the $40 million in penalties to investors harmed by the Tweet.

“The total package of remedies and relief announced today are specifically designed to address the misconduct at issue by strengthening Tesla’s corporate governance and oversight in order to protect investors,” said Stephanie Avakian, Co-Director of the SEC’s Enforcement Division.

“As a result of the settlement, Elon Musk will no longer be Chairman of Tesla, Tesla’s board will adopt important reforms —including an obligation to oversee Musk’s communications with investors—and both will pay financial penalties,” added Steven Peikin, Co-Director of the SEC’s Enforcement Division.  “The resolution is intended to prevent further market disruption and harm to Tesla’s shareholders.”

[Ed. Note: To this Blog’s knowledge, the SEC action against Musk marks the first enforcement action against a defendant for making false and misleading statements and omissions in a Twitter account. The action sends a message to corporate officers and directors that truth, candor and accuracy of corporate communications are necessary regardless of the medium in which they are made. Thus, corporate officers and directors who use social media, without the oversight, review, and scrutiny attendant to communications issued through more traditional means, risk scrutiny from the SEC if their communications are alleged to be materially false and misleading. The SEC’s complaint underscores this point.]

Trade Executions:

On September 28, 2018, the SEC announced (here) that Credit Suisse Securities (USA) LLC (“Credit Suisse”) agreed to settle charges brought by the Commission and the New York Attorney General’s Office (“NYAG”) concerning misrepresentations and omissions made in connection with the handling of certain customer orders by the firm’s now-closed Retail Execution Services (“RES”) business.  The settlements require Credit Suisse to pay $5 million to the SEC and $5 million to the NYAG.

According to the SEC (here), Credit Suisse created the RES desk to execute orders for other broker-dealers that handle order flow on behalf of retail investors.  Although the RES desk promoted its access to dark pool liquidity to customers, the firm executed an exceedingly minimal number of held orders – orders that must be executed immediately at the current market price – in dark pools during the period September 2011 to December 2012.

The SEC found that although Credit Suisse touted “robust” and “enhanced” price improvement on orders, the RES desk’s computer code treated orders for which execution quality is required to be publicly reported differently from orders for which execution quality is not publicly reported.  From mid-2011 to March 2015, retail customers did not receive any price improvement from the RES desk on their non-reportable orders, which Credit Suisse failed to disclose.  The SEC further found that for the non-reportable orders, the RES desk disproportionately used a routing tactic that generally caused market impact and resulted in less favorable execution prices for customers, despite claiming to benefit Credit Suisse’s customers.  The use of this routing tactic provided the RES desk an opportunity to profit from its execution of the final portions of those customer orders internally.

“Market makers that handle retail orders must be transparent with their customers about how orders will be executed and how the market maker will profit from their customers’ trades,” said Marc P. Berger, Director of the SEC’s New York Regional Office.  “The settlement holds Credit Suisse accountable for failing to accurately disclose important information about the nature and quality of its execution of trades for retail investors.”

The SEC’s order finds that Credit Suisse negligently violated Section 17(a)(2) of the Securities Act.  In addition to imposing the penalty, the SEC’s order censures Credit Suisse and requires that it cease and desist from further violations.  Credit Suisse consented to the SEC’s order without admitting or denying the findings.

Suspicious Activities:

On September 28, 2018, the SEC announced (here) that it had settled charges against clearing firm COR Clearing LLC (“COR”) for failing to report suspicious sales of penny stock shares totaling millions of dollars.  As part of the settlement, COR agreed to exit a key penny stock clearing business by significantly limiting the sale of penny stocks deposited at COR.

Microcap securities, such as penny stocks, are susceptible to manipulation (here). Publicly-available information about microcap companies (which are typically less liquid than the larger companies) often is scarce, making it easier for fraudsters to spread false information and manipulate the price of microcap stocks. Consequently, broker-dealers are required to file Suspicious Activity Reports (“SARs”) for transactions suspected of having no lawful purpose or to involve fraud.

In 2016, COR ranked second among all broker-dealers in the total dollar value of sub-$1 penny stock that it cleared, and from January 2015 to June 2016, COR cleared for sale a significant amount of penny stocks on behalf of customers of its introducing broker-dealers.  The SEC found (here) that approximately 193 customer accounts deposited large blocks of low-priced securities, quickly sold those securities into the market, and then withdrew the cash proceeds.  The SEC further found that in some instances the same customers engaged in this suspicious pattern with multiple securities.  According to the SEC, COR failed to file SARs with respect to a subset of the foregoing transactions and, as a result, violated the securities laws.

“SAR filings by both introducing and clearing brokers, especially those who transact in the microcap space, are critically important to the regulatory and law enforcement communities,” said Marc P. Berger, Director of the SEC’s New York Regional Office.  “The penalty imposed and the limitation placed on COR’s business reflect how seriously we take the failure to file SARs in the face of numerous red flags.”

Without admitting or denying the SEC’s findings, COR agreed to a settlement that requires it to not sell penny stocks deposited at COR with certain narrow exceptions and pay an $800,000 penalty.  COR also consented to a censure and to cease and desist from similar violations in the future.

Fraudulent “Cherry-Picking” Scheme:

On September 28, 2018, the SEC announced (here) that it charged Michael A. Bressman (“Bressman”), a New Jersey-based broker, with misusing his access to customers’ brokerage accounts to enrich himself and family members at the expense of his customers, many of whom entrusted him with their retirement accounts.

The SEC filed fraud charges in the United States District Court for the District of Massachusetts against Bressman, alleging that he misused his access to an omnibus or “allocation” account to obtain at least $700,000 in illicit trading profits over a six-year period ending in February. In its complaint (here), the SEC alleged that Bressman placed trades using the allocation account and cherry-picked profitable trades, which he then transferred to his own account and the account of two family members, while placing unprofitable trades in other customers’ accounts. Cherry-picking occurs when a broker, who buys and sells securities on behalf of his brokerage customers, defrauds those customers by purchasing stock and then waiting to see whether the price of the stock goes up, or down, before allocating the trade. If the stock goes up, the broker keeps the trade for himself/herself or a set of “favored” accounts. If the stock goes down, the broker puts the trades into other, disfavored customer accounts. In other words, the broker “cherry-picks” the profitable trades for himself/herself or certain favored accounts, while giving unprofitable trades to his/her other customers.

In a parallel action, the U.S. Attorney’s Office for the District of Massachusetts announced (here) criminal charges against Bressman.

The SEC charged Bressman with violating various securities laws and rules, including Sections 17(a)(1) and 17(a)(3) of the Securities Act of 1933 and Section 10(b) of the Securities Exchange Act and Ruled 10b-5(a) and 10b-5(c) thereunder. The SEC is seeking return of allegedly ill-gotten gains, plus interest, penalties and a permanent injunction.

False ADV and Website:

On September 28, 2018, the SEC announced (here) that it filed charges against an Australia-based investment adviser Goldsky Asset Management, LLC (“Goldsky”) and its owner, Kenneth Grace (“Grace”), for making false and misleading statements about Goldsky’s business in filings with the Commission and on its website.

According to the SEC, Goldsky’s Forms ADV filed with the Commission in 2016 and 2017, which Grace signed, stated that the firm’s hedge fund, Goldsky Global Alpha Fund, LP (the “Goldsky Fund”), had an auditor, a prime broker and custodian, and an administrator. In addition, in its Forms ADV and Forms ADV Part 2A, Goldsky stated that it had over $100 million in discretionary assets under management. Goldsky’s website also claimed that the Goldsky Fund earned: 19.45% compounded annual returns since inception, 70.33% compounded monthly returns since inception, and 25.30% returns for the year ended September 30, 2017. In its complaint (here), the SEC alleged that these statements were false and misleading because Goldsky, Grace and the Goldsky Fund had no agreements with service providers, Goldsky and Grace did not manage $100 million of assets, and the Goldsky Fund did not have any investment returns as it never had any assets.

The SEC’s complaint, filed in the United States District Court for the Southern District of New York, charges Goldsky and Grace with violating the antifraud provisions of Sections 17(a)(1) and 17(a)(3) of the Securities Act of 1933, Sections 206(4) and 207 of the Investment Advisers Act of 1940 and Rule 206(4)-8 thereunder, or in the alternative, that Grace aided and abetted Goldsky’s violations. The SEC is seeking a judgment ordering permanent injunctive relief and civil monetary penalties against Goldsky and Grace.

Rags-to-Riches Fraud:

On September 27, 2018, the SEC announced (here) that it charged a group of internet marketers who created and disseminated elaborate rags-to-riches videos to trick retirees and other retail investors into opening brokerage accounts and trading high-risk securities known as binary options. (A discussion of binary option fraud can be found here.)

According to the SEC, investors were conned out of tens of millions of dollars through these marketing campaigns, which promised that investors would make large amounts of money by opening binary options accounts and using free or secret software systems to trade in them. In its complaints, the SEC alleged that the marketers were paid for each new brokerage account that investors opened and funded. According to the SEC, the marketers’ internet video advertisements, which were disseminated through spam emails, used actors to portray ordinary people who became millionaires by trading binary options. The videos staged fake demonstrations of supposed software users watching their account balances grow in real time. The SEC alleged that the software was simply a ruse to persuade investors to open accounts with the brokers.

“As alleged in our complaints, thousands of retail investors were swindled out of tens of millions of dollars by watching elaborately produced rags-to-riches stories that falsely promised wealth at the push of a button,” said Melissa Hodgman, Associate Director of the SEC’s Enforcement Division. “Those who use phony tactics to dupe investors out of their savings will be held accountable for false and misleading statements on the internet.”

“Before you provide any of your valuable personal information to anyone, make sure you do your research and know exactly who it’s going to,” said Lori Schock, Director of the SEC’s Office of Investor Education and Advocacy.  “Be aware before you share, and protect yourself from professional fraudsters who may target you and your money for life.”

The SEC’s complaints charge 10 individuals and two companies involved in the fraudulent marketing campaigns. The SEC is seeking penalties, disgorgement of ill-gotten gains, and permanent injunctions. Without admitting or denying the charges, seven of the settling defendants agreed to pay a combined total of $4.1 million in disgorgement and prejudgment interest. The Commission did not assess a penalty on the other settling parties as a result of their cooperation.

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