Securities Snapshot January 29, 2019

Northern District of California Rejects SEC’s Attempt to Obtain Disgorgement from Relief Defendant

Summary

Northern District of California denies SEC’s attempt to obtain disgorgement from relief defendant; ex-Georgeson LLC advisor convicted in a tix-for-votes scheme; RICO suit over the use of robo-advisors dismissed for failure to adequately allege a criminal enterprise; government adequately pleads “tippee” liability under recent Second Circuit precedent.

Northern District of California Rejects SEC’s Attempt to Obtain Disgorgement from Relief Defendant

On January 11, 2019, U.S. District Court Judge Richard Seeborg in the Northern District of California granted the Securities Exchange Commission’s (“SEC”) motion for partial summary judgment in a civil enforcement action involving an alleged EB-5 investment fraud scheme, and ordered disgorgement of nearly $24 million in ill-gotten gains, but held that the SEC could not require a relief defendant to disgorge amounts it never received. The SEC sought partial summary judgment in the form of a finding that North America 3PL, LLC (“NA3PL”) and San Francisco Regional Center, LLC (“SFRC”), violated the federal securities laws by perpetrating a scheme to defraud foreign investors seeking U.S. permanent residency under the EB-5 visa program. The SEC alleged that from May 2014 to March 2016, NA3PL and SFRC solicited at least $22 million from EB-5 investors for a warehouse project under the guise of job creation. Rather than using the funds for the project, NA3PL and SFRC diverted most of those funds to unrelated accounts. The judge granted this unopposed portion of the motion, characterizing the SEC’s allegations as “well-supported by the record.”

The SEC further sought an order requiring NA3PL and a “relief” defendant, Berkeley Healthcare Dynamics, LLC (“BHD”), the owner of the warehouse that was intended to house one of the fraudulent EB-5 businesses, to jointly and severally disgorge $23.9 million in ill-gotten gains from the scheme. The judge granted the SEC’s request for an order of disgorgement against NA3PL, but found that the SEC did not show that BHD was ever in possession of the funds from the fraud scheme. Relying on Ninth Circuit precedent, including SEC v. World Capital Market, Inc., 864 F.3d 996, 1004 (9th Cir. 2017), the court held that “[w]hile it is no defense to an obligation to disgorge that a party no longer has the funds, the SEC has not shown any legal basis to require an entity—particularly a relief defendant who has not even been charged with wrongdoing—to ‘disgorge’ something it never had.” The court also rejected the SEC’s argument that BHD should nevertheless be required to disgorge “given its close relationship to other defendants, the complicated intermingling of funds, overlapping ownership, and similar factors,” because having not previously sought to pursue such claims against BHD, “the SEC cannot transform it from a relief defendant to a full defendant in the context of this motion.”

Ex-Georgeson LLC Advisor Convicted of Fraud and Conspiracy in Tix-for-Votes Scheme

On January 15, 2019, a federal jury in the District of Massachusetts convicted a former Georgeson LLC adviser, Donna Ackerly, on fraud and conspiracy charges for her role in a scheme to bribe an employee at proxy advisor Institutional Shareholder Services Inc. (“ISS”) in exchange for early access to shareholder voting data for some of the world’s largest companies. After an earlier mistrial in March 2018, a jury found Ackerly guilty of wire fraud, honest services fraud, and conspiracy to commit those crimes—after only a few hours of deliberation. According to the government, Ackerly and other ex-Georgeson employees conspired to gain an “illicit business advantage” by bribing the ISS employee with roughly $14,000 worth of sports and concert tickets in exchange for early access to confidential client information.  The defendants allegedly used the confidential information, including information about how ISS clients had voted on particular shareholder proposals, “to advise their clients on matters requiring shareholder approval.” The government further alleged that Ackerly assisted in efforts to mislead Georgeson’s clients into paying at least part of the costs of the bribes by arranging to have the bribes billed to clients using false descriptions such as “courier services.” Prosecutors previously characterized the tix-for-votes scheme as part of a “black market for confidential corporate information,” and signaled an increased focus on investigations into those who pay bribes or kickbacks for that information outside the traditional realm of insider trading. This prosecution is an example of the government’s ability to charge honest services fraud to reach undisclosed self-dealing in a commercial context.  Ackerly faces up to 20 years in prison at her April 15, 2019, sentencing.

Relatedly, prosecutors are appealing U.S. District Judge Richard G. Stearns’ decision to bar retrial of Ackerly’s three co-defendants on the grounds of double jeopardy. Georgeson previously agreed to pay $4.5 million in 2017 and enter into a deferred prosecution agreement to resolve related charges against the company.

Civil RICO Suit Over Robo-Advisors Dismissed for Failure to Plead the Existence of an “Enterprise” Amid Increase in Civil Rico Actions

On January 16, 2019, U.S. District Judge Virginia M. Kendall in the Northern District of Illinois held for the second time in Green v. Morningstar, Inc. et al, that Morningstar Investment Management LLC and two Prudential Financial Inc. retirement-focused subsidiaries won’t face allegations that they illegally colluded to profit from a robo-adviser program. A retirement investment plan participant pursued the civil action against the defendants under the Racketeer Influenced and Corrupt Organizations Act (“RICO”). The plan participant, seeking to represent up to 5 million investors in hundreds of retirement plans, alleged that defendants used an automated investment advice program to intentionally and systematically steer investors into high-fee mutual funds that provided revenue-sharing fees to the defendants. Green is part of a significant increase in civil RICO filings in 2018, with litigants bringing more than twice the number of actions as in 2017.

Judge Kendall held that Green failed to plead the existence of an “enterprise” or “a pattern of racketeering activity,” or that defendants caused his injury—all of which are elements of a civil RICO claim. Green failed to plead the existence of an enterprise because he did not “distinguish between the illicit purpose of the enterprise and the lawful purpose of the defendant businesses.” The Court explained that “[t]here is nothing inherently nefarious about the defendants wanting to become a leader in the market for retirement plan automated investment advice programs to maximize their profits.” Green also failed to plead a pattern of racketeering activity because neither of the statutes invoked actually prohibited the conduct at issue, i.e., revenue-sharing that is fully disclosed to plan participants. Green’s civil RICO claim also failed because the causal connection between the alleged misconduct (siphoning of fee-sharing payments to defendants) and the alleged harm (higher fees) was too attenuated.     

Finally, the court noted that even if the amended complaint had sufficiently pleaded a RICO claim, it would be barred by the relevant four-year statute of limitations because the plaintiff investment plan participant should have known about the plan fees as far back as 2012.

Illinois District Judge Finds Government Adequately Pleaded “Tippee” Liability Under Salman v. United States

On January 22, 2019, U.S. District Judge Matthew F. Kennelly in the Northern District of Illinois rejected a motion to dismiss filed by Austin Mansur and Eric Weller, two of nine co-defendants charged for their role in an alleged scheme to illegally trade Life Time Fitness, Inc. (“Life Time”) call options based on insider information. The government alleges that a Lifetime Fitness corporate insider, who learned that private equity firms were in discussions to acquire Life Time, tipped a close friend about the deal, and that the tippee then relayed that information to three friends. One of those friends then provided the information to four other friends, including Mansur and Weller. The government further alleged that at each step, the tippers provided the information to close friends in exchange for a cut of their trading profits. Six of the tippees collectively purchased around 2,000 call options for roughly $106,000 and later sold them at a profit of nearly $866,000. 

Mansur and Weller argued in their motion to dismiss that the government failed to allege that they knew the Life Time insider (the original tipper) had received a personal benefit and that allegations about friendship were insufficient to establish such a benefit. The court rejected that argument, explaining that under the Supreme Court’s decision in Salman v. United States, “personal benefit to an insider may be inferred when the insider tips a close friend.” Because Mansur and Weller were alleged to have known that the corporate insider had disclosed information in breach of his fiduciary duty and that the person who tipped them had obtained the information from a corporate insider who was a close personal friend, the Court found that the indictment adequately alleged that Mansur and Weller were aware of the benefit to the tipper.

The court also rejected Mansur and Weller’s argument that the indictment was internally contradictory because it alleged both that the tipper and the first tippee were close friends and that the tipper had provided the information to the first tippee in exchange for money, holding that “nothing in section 10(b) or the cases interpreting it require a tipper to gain one, and only one, benefit from disclosing information.”