More On Legal & Compliancefrom The Advisor's Professional Library
- Client Communication and Miscommunication RIA policies and procedures must specify what type of communications should be retained. The safest course of action is for RIAs to retain all communicationsto clients, from clients, and about client accounts. To comply with fiduciary obligations, communications must be thorough and not mislead.
- Agency and Principal Transactions In passing Section 206(3) of the Investment Advisers Act, Congress recognized that principal and agency transactions can be harmful to clients. Such transactions create the opportunity for RIAs to engage in self-dealing.
Among recent enforcement actions taken by the SEC were charges against a Miami-based entrepreneur for defrauding investors against a hedge fund manager for trading illegally in Chinese stocks, which cost the manager and his firms $44 million in disgorgement and penalties; charges against a Florida-based securities lawyer for forging attorney opinion letters on microcap stocks; and charging a New York-based fund manager for running fraudulent trading schemes, as well as charges against a New Jersey-based cosultant to Chinese reverse merger companies for securities law violations.
Hedge Fund Manager Pays $44 Million over Illegal Chinese Stock Trades
Sung Kook “Bill” Hwang of Tenafly, N.J., the founder and portfolio manager of Tiger Asia Management and Tiger Asia Partners, two New York-based hedge funds, was charged by the SEC with conducting a pair of trading schemes involving Chinese bank stocks that made $16.7 million in illicit profits.
The SEC also charged Raymond Y.H. Park, of Riverdale, N.Y., for his roles in both schemes as the head trader of the two hedge funds involved: Tiger Asia Fund and Tiger Asia Overseas Fund. In a parallel action, the U.S. Attorney’s Office for the District of New Jersey also announced criminal charges against Tiger Asia Management.
According to the SEC, Hwang committed insider trading by short selling three Chinese bank stocks based on confidential information he and his firms received in private placement offerings. Hwang and his firms then covered the short positions with private placement shares purchased at a significant discount to the stocks’ market price.
According to the SEC’s complaint filed in federal court in Newark, N.J., from December 2008 to January 2009, Hwang and his advisory firms participated in two private placements for Bank of China stock and one private placement for China Construction Bank stock. Before disclosing material nonpublic offering information, the placement agents required wall-crossing agreements from Park and the firms to keep the information confidential and refrain from trading until the transaction took place.
Despite agreeing to those terms, Hwang ordered Park to make short sales in each stock in the days prior to the private placement. Hwang and his firms illegally profited by $16.2 million by using the discounted private placement shares they received to cover the short sales they had entered into based on inside information about the placements.
The SEC further alleges that on at least four occasions from November 2008 to February 2009, Hwang and his firms, with Park’s assistance, attempted to manipulate the month-end closing prices of Chinese bank stocks publicly listed on the Hong Kong Stock Exchange. These stocks were among the largest short position holdings in the hedge funds’ portfolios.
The manipulation was designed to lower the price of the stocks and increase the value of the short positions, thus enabling Hwang and Tiger Asia Management to illicitly collect higher management fees from investors. The more assets the hedge funds had under management, the greater the management fee that Tiger Asia Management was entitled to collect.
So Hwang directed Park to place losing trades; this would depress the stock prices and inflate the calculation of the management fees. Hwang and Tiger Asia Management made approximately $496,000 in fraudulent management fees through this scheme.
Hwang and his firms have agreed to pay $44 million to settle the SEC’s charges. The settlements, subject to court approval, require Hwang, Tiger Asia Management, and Tiger Asia Partners to collectively pay $19,048,787 in disgorgement and prejudgment interest. Each has agreed to pay a penalty of $8,294,348 for a total of 24,883,044.
Park also agreed to pay $39,819 in disgorgement and prejudgment interest, and a penalty of $34,897. With the exception of Tiger Asia Management, the defendants neither admit nor deny the charges.
Consultant to Chinese Reverse Merger Companies Charged
Huakang “David” Zhou, a New Jersey-based consultant, was charged by the SEC with violating securities laws and defrauding some investors while helping Chinese companies gain access to the U.S. capital markets.
The SEC alleges that Huakang “David” Zhou and his consulting firm Warner Technology and Investment Corp. located more than 20 private companies in China to bring public in the U.S. through reverse mergers, and then committed various securities laws violations in the course of advising those companies and later assuming operational roles at some of them.
After earning millions of dollars in consulting fees, Zhou and his firm have left several failed Chinese companies in their wake in the U.S. markets including China Yingxia International, whose registration was revoked after the company collapsed amid fraud allegations. Zhou’s son as well as a number of other individuals and firms have previously been charged with misconduct related to China Yingxia.
The SEC alleges that the elder Zhou engaged in varied misconduct ranging from nondisclosure of certain holdings and transactions to outright fraud. For instance, Zhou failed to disclose to investors in one company that he engaged in questionable wire transfers of their money to evade Chinese currency regulations, and he orchestrated an elaborate scheme to meet the requirements necessary to list a purported Chinese real estate developer on a national securities exchange. Zhou also stole $271,500 in investment proceeds from a capital raise to make mortgage payments on a million-dollar condo where his son lives in New York City.
According to the SEC’s complaint filed in U.S. District Court for the Southern District of New York, Warner Technology and Investment Corporation advertises itself on its website as the first U.S. consulting firm that successfully brought a Chinese private company public in the U.S. through a reverse merger with an OTCBB trading company.
Zhou’s misconduct occurred from at least 2007 to 2010. After completing the reverse mergers, Zhou strongly influenced or even directed many of his clients’ newfound U.S. presence and obligations as public companies. He opened and controlled U.S. bank accounts for many of his clients to pay for services rendered and receive any proceeds from fundraising done in the U.S. This enabled Zhou to control how and when offering proceeds were wired to China, and gave him the ability to direct money to himself purportedly to collect fees or repay loans made to the companies.
The SEC alleges that while Zhou raised $2 million for client American Nano Silicon Technologies, he concealed from investors that their money would be put at risk due to the circuitous way he purportedly sent investment proceeds to China. Unknown to investors, Zhou controlled a U.S. bank account for the issuer and sent hundreds of thousands of dollars by wire transfer to multiple individuals in China who had no apparent affiliation with American Nano. The individuals were to then wire the money to the company’s CEO, who would transfer the money to the company’s Chinese bank account. Zhou failed to disclose to investors that he engaged in these questionable wire transfers to evade Chinese currency regulations.
Although investment proceeds were in part used for seemingly legitimate company expenses in the U.S. such as to pay accountants, the transfer agent, and an investment bank, Zhou used some of the money as his own. In addition to the $271,500 of investor money he used for mortgage payments, he paid his wife a “refund” of $40,000 for undisclosed reasons and wrote a check for $5,824 to “cash.”
The SEC alleges that Zhou engaged in manipulative trading as part of his scheme to list China HGS Real Estate on a national exchange, including matched orders to meet the $4 minimum bid required for listing. Through gifts of stock and a purportedly private sale to a broker-dealer, Zhou schemed to artificially create a sufficient number of shareholders to meet a listing requirement to have more than 400 “round lot shareholders” with 100 shares or more. The scheme succeeded, and Zhou’s client was approved for listing on the exchange.
According to the SEC’s complaint, Zhou engaged in unregistered sales of securities for several clients, including a $5 million offering to roughly 85 Chinese-Americans living in several U.S. states. Zhou and his firm also improperly assisted with securities offerings for two clients while not registered as broker-dealers, and they aided and abetted violations by other unregistered brokers.
The SEC’s complaint against Zhou and Warner Technology and Investment Corp. alleges violations of Sections 5(a), 5(c), and 17(a) of the Securities Act of 1933, Sections 10(b), 13(d), 15(a), and 16(a) of the Securities Exchange Act of 1934, and Rules 10b-5, 13d-1, 13d-2, and 16a-3. It further charges Zhou for control person liability and aiding and abetting violations of Section 10(b) and 15(a) of the Exchange Act, and Rule 10b-5(b).
Securities Lawyer Charged with Forging Attorney Opinion Letters
The SEC has charged securities lawyer Guy Jean-Pierre of Pompano Beach, Fla., also known as Marcelo Dominguez de Guerra, with issuing fraudulent attorney opinion letters that resulted in more than 70 million shares of microcap stock becoming available for unrestricted trading by investors.
Jean-Pierre was banned by the Pink Sheets (now OTC Markets Group) in April 2010 from issuing attorney opinion letters–required from a licensed and duly authorized securities lawyer to facilitate the transfer of restricted microcap shares on the over-the-counter markets–due to “repeated missing information and inconsistencies” about the issuers and his lack of due diligence in his past letters.
However, a ban apparently was not enough to stop Jean-Pierre from conducting business as usual. The SEC alleges that he has since engaged in a scheme to continue writing and issuing attorney opinion letters in the name of his niece by applying her signature without her consent, and even formed a new company to do so: Complete Legal Solutions. He misrepresented that his niece conducted the legal work allegedly performed, when he never requested any such work of her and she was not paid for such work.
According to the SEC’s complaint filed in U.S. District Court for the Southern District of New York, within two weeks of his ban, Jean-Pierre hatched his plan to continue issuing attorney opinion letters through Complete Legal and his niece’s identity.
He told his niece, a licensed attorney who was looking for work at the time, about his work issuing attorney opinion letters, and offered to pay her to assist him. He suggested they form Complete Legal and asked her to send him three copies of her signature and a copy of her driver’s license. She complied, with the understanding this information was needed to incorporate Complete Legal.
Instead, the SEC alleges that Jean-Pierre continued to issue attorney opinion letters using Complete Legal and his niece’s identity. Each letter contained fraudulent statements and falsely represented his niece as the signatory. Jean-Pierre’s niece did not write any of the letters and did not make the representations concerning the issuers.
Jean-Pierre fabricated attorney opinion letters on Complete Legal letterhead for at least 11 companies that traded publicly on the Pink Sheets. Certain letters resulted in Pink Sheet issuers being granted the improved status of having adequate current information in the public domain under Rule 144(c)(2) of the Securities Act of 1933. This status kept the issuers from being tagged on the Pink Sheets’ website with a red “STOP” sign near its ticker symbol with the moniker of “OTC Pink No Information” and a large warning that the company “may not be making material information publicly available.”
According to the SEC’s complaint, adequate current public information about an issuer must be available for certain selling security holders to comply with the Rule 144 safe harbor allowing companies to issue unregistered securities pursuant to Section 4(1) of the Securities Act. Jean-Pierre falsely issued letters bearing his niece’s signature to transfer agents opining that restrictive legends could be legally removed from either preexisting stock certificates or newly issued stock certificates pursuant to Rules 144 or 504 of the Securities Act.
The SEC is seeking disgorgement of ill-gotten gains with prejudgment interest and financial penalties, a permanent injunction, and a bar from participating in the offering of any penny stock pursuant to Section 20(g) of the Securities Act. Its investigation is continuing.
Miami Entrepreneur Charged with Defrauding Investors
A prominent Miami-based entrepreneur was charged by the SEC with defrauding investors by grossly exaggerating the financial success of his company, InnoVida, which purportedly produced housing materials to withstand fires and hurricanes. Claudio Osorio stole nearly half the money raised from investors to pay the mortgage on his multimillion-dollar mansion and other lavish living expenses.
The agency also charged InnoVida’s chief financial officer Craig Toll, a certified public accountant living in Pembroke Pines, Fla., who helped Osorio create the false financial picture of InnoVida. In a parallel action, the U.S. Attorney’s Office for the Southern District of Florida also announced criminal charges against Osorio and Toll.
According to the SEC’s complaint filed in U.S. District Court for the Southern District of Florida, the scheme began in 2007 and lasted until 2010. InnoVida was purportedly in the business of manufacturing building panels used to construct houses and other structures resistant to fires and hurricanes. The company entered bankruptcy in 2011.
The SEC alleges that Osorio, a former Ernst & Young Entrepreneur of the Year award winner, raised at least $16.8 million from investors by portraying InnoVida Holdings LLC as having millions of dollars more in cash and equity than it actually did. Osorio sometimes solicited investors one-on-one at political fundraising events. To add an air of legitimacy to his company, Osorio assembled a high-profile board of directors that included a former governor of Florida, a lobbyist, and a major real estate developer.
To induce funds from investors, Osorio and Toll allegedly produced false pro forma financial statements. A pro forma financial statement for March 31, 2009, stated that InnoVida had more than $35 million in cash and cash equivalents and more than $100 million of equity. A pro forma financial statement for Dec. 31, 2009, listed more than $39 million in cash and cash equivalents and $122 million of equity. In reality, the company’s bank accounts held less than $185,000 on March 31, 2009, and less than $2 million on Dec. 31, 2009.
Toll failed to review all of InnoVida’s bank account statements when he drafted financial statements. Instead, he accepted Osorio’s misrepresentations that InnoVida had these assets in an account to which Toll did not have access.
The SEC alleges that Osorio offered bogus share prices to prospective investors based on false valuations. He told one investor that InnoVida was valued at $250 million, and then a week later told a different investor that the company was worth $50 million. The latter investor purchased $100,000 of Osorio’s stake in the company for five cents per share.
The SEC further alleges that Osorio lied to an investor when he said that he had personally invested tens of millions of dollars into InnoVida. He had in fact made no such investment.
Osorio also enticed an investor to increase an investment in InnoVida by touting a supposed $500 million deal he was negotiating with a Middle Eastern sovereign wealth fund that would significantly benefit InnoVida investors. Osorio went so far as to create a document showing the investor how much he would make once the sovereign wealth deal closed and was funded.
Based on Osorio’s misrepresentations, the investor was able to raise approximately $700,000 and later borrowed $3 million from a close friend. However, no sovereign wealth buyout deal ever materialized, and InnoVida investors never benefited as promised.
The SEC alleges that besides his Miami Beach mansion, Osorio illegally used investor money to pay for his Maserati, a Colorado mountain retreat home, and country club dues. He stole at least $8.1 million in investor funds. The complaint seeks disgorgement of ill-gotten gains, financial penalties, and injunctive relief against InnoVida, Osorio, and Toll to enjoin them from future violations of the federal securities laws. The complaint also seeks an order barring Osorio and Toll from serving as an officer or director of a public company.
Fund Manager Charged with Running Fraudulent Trading Schemes
Steven Hart, a New York-based fund manager, was charged by the SEC with conducting a pair of illegal trading schemes to financially benefit his investment fund Octagon Capital Partners LP.
The SEC alleges that Hart made $831,071 during a four-year period through illicit trading while also working as a portfolio manager and employee at a New Jersey-based firm that served as an adviser for several affiliated investment funds. In one scheme, Hart illegally matched 31 premarket trades to benefit his own fund at the expense of one of his employer’s funds. In the other scheme, he conducted insider trading in the securities of 19 issuers based on nonpublic information he learned in advance of their offering announcements. Furthermore, he signed two securities purchase agreements falsely representing that he had not traded the issuer’s securities prior to the public announcement of the offerings in which he had been confidentially solicited to invest.
According to the SEC’s complaint filed in U.S. District Court for the Southern District of New York, Hart conducted his schemes from 2007 to 2011. He caused Octagon to purchase stock in small, thinly traded issuers at the going market price so that he could sell the same stock the following day to his employer’s fund at a price substantially above the prevailing market price. Each of the sales from Octagon to the employer’s fund occurred in premarket trading; that way Hart was able to ensure that the trades matched. Later that same day or within a few days of the matched trades, Hart directed the employer’s fund to sell the recently acquired stock on the open market at a loss. This scheme generated $586,338 in ill-gotten gains for Octagon.
The SEC’s complaint also says Hart was confidentially solicited by 19 issuers to invest in securities offerings where he expressly agreed to go “over-the-wall” and keep confidential the information he received and not trade on it. Nevertheless, Hart traded for Octagon, bringing in $244,733 in more ill-gotten gains, on the basis of material nonpublic information about the offerings. Hart’s illegal trades involved PIPE offerings, registered direct offerings, and confidentially marketed public offerings.
The SEC alleges that, to induce two issuers to sell securities to his fund, Hart signed securities purchase agreements falsely representing that Octagon had not traded the issuers’ securities after he had been solicited. Despite going “over-the-wall” during the solicitations conducted by the two issuers, Hart directed short sales of these issuers’ securities and obtained insider trading profits. He subsequently signed the securities purchase agreements misrepresenting that he hadn’t traded in their securities in the days leading up to the public announcements about the offerings.
Without admitting or denying the allegations, Hart has agreed to pay more than $1.3 million to settle the SEC’s charges: $831,071 in disgorgement, $103,424 in prejudgment interest, and a $394,733 penalty. He also consented to the entry of a judgment enjoining him from future violations of the respective provisions of the Securities Act, Exchange Act and Advisers Act. The settlement is subject to court approval.