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Regulation and Compliance > Federal Regulation > SEC

Judge Intervenes After SEC Creates Wrongful BD ‘Death Spiral’

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A forceful intervention by a federal judge has turned a $19 million Securities and Exchange Commission case against Panamanian broker-dealer Verdmont Capital for an international penny stock scheme into a $240,000 case.

In February, the SEC announced with great fanfare the halt of what it characterized as an international scheme to sell penny stocks in unregistered distributions and sham offerings. 

The SEC filed its complaint and request for an emergency asset freeze in federal court in New York. Most of the press coverage surrounded the run on the bank and receivership caused by the SEC’s action against Cayman Islands based Caledonian Bank. But a lesser-noticed aspect of the SEC action is now coming to light involving Panamanian broker-dealer Verdmont Capital.

(Caledonian Bank and Verdmont Capital are not affiliated, but both entities were used in the penny stock scheme).

Initially, the SEC obtained a $19 million asset freeze against Verdmont, which was based on an incomplete SEC investigation and a number of incorrect assumptions by the SEC.

First, the SEC apparently did not understand that the funds subject to its emergency asset freeze belonged to Verdmont’s clients, not Verdmont. 

Second, the SEC obtained its freeze under the mistaken belief that Verdmont had sold the securities in the unregistered distributions at issue for its own account rather than on behalf of customers. 

Finally, the SEC incorrectly believed that certain entities had accounts at Verdmont. Of the three Verdmont clients named by the SEC, one was never a client, one had closed its accounts in October 2014, and one was a current client.

The SEC’s asset freeze against Verdmont began to unravel on Feb. 27, when the SEC agreed to reduce the amount of its asset freeze from $19 million to $2 million. Even this amount dwarfed the total amount of commissions Verdmont earned on the transactions criticized by the SEC. 

The commissions amounted to about $240,000, but the SEC demanded $2 million be frozen because it viewed Verdmont as jointly and severally liable for the profits made by its customers and $2 million was the amount the SEC felt that Verdmont could pay without going below its net capital requirements.

In a May 21 hearing, the federal court judge presiding over the case, subjected the SEC to withering criticism for its failure to fully investigate its case before obtaining an asset freeze that put Verdmont into a “death spiral.” 

At one point, the judge asked the SEC attorney whether “the SEC has a canon of ethics . . . that the power to investigate carries with it the power to defame and destroy.”  The judge concluded, “There’s been a lot of that going on in this case.”  The judge scheduled an evidentiary hearing on the matter for June 8.

Before that hearing could take place, the SEC agreed to limit its asset freeze to the $240,000 allegedly representing Verdmont’s commissions. The SEC also amended its complaint, revising its allegations against Verdmont. 

The SEC’s central allegation remains unchanged: Verdmont violated the registration provisions of the federal securities laws by effecting transactions in securities for its clients despite the absence of a restrictive legend on the shares and despite the existence of a registration statement for the securities. What has changed, but only after forceful intervention by a federal judge, is the SEC’s initial claim that Verdmont could be jointly and severally liable for the trading profits of its customers. A $19 million case is now a $240,000 case.

Unfortunately for Verdmont, over a period of several months it bore the brunt of the SEC’s “power to defame and destroy” as a result of a rush to court based on faulty assumptions and aggressive legal theories.


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