SEC Charges Four Public Companies With Longstanding ICFR Failures

The Securities and Exchange Commission today announced settled charges against four public companies for failing to maintain internal control over financial reporting (ICFR) for seven to 10 consecutive annual reporting periods. Two of the charged companies also failed to complete the required evaluation of the effectiveness of ICFR for two consecutive annual reporting periods.

According to the SEC’s orders, year after year, the four companies disclosed material weaknesses in ICFR involving certain high-risk areas of their financial statement presentation. As discussed in the SEC orders, each of the four companies took months, or years, to remediate their material weaknesses after being contacted by the SEC staff. One of the companies is still in the process of remediating its material weaknesses.

“Adequate internal controls are the first line of defense in detecting and preventing material errors or fraud in financial reporting,” said SEC Chief Accountant Wesley Bricker.  “When internal control deficiencies are left unaddressed, financial reporting quality can suffer.” 

Melissa Hodgman, an Associate Director in the SEC’s Enforcement Division, added, “Companies cannot hide behind disclosures as a way to meet their ICFR obligations. Disclosure of material weaknesses is not enough without meaningful remediation. We are committed to holding corporations accountable for failing to timely remediate material weaknesses.” 

Without admitting or denying the findings, each of the four companies agreed to a cease and desist order making certain findings, requiring payment of civil penalties, and requiring an undertaking for one of the companies as detailed below:

• Grupo Simec S.A.B de C.V. disclosed material weaknesses in its annual filings for 10 consecutive years, from 2008 to 2017. In both 2015 and 2016, its management failed to complete the required ICFR evaluation. The company did not make significant progress in devising a control structure and remediating material weaknesses until after the SEC staff contacted it. The company continues to have material weaknesses that are being addressed through remediation. The Commission’s settled order includes violations of Exchange Act Section 13(b)(2)(B) and Rules 13a-15(a) and 13a-15(c), thereunder, payment of a $200,000 civil penalty, and an undertaking requiring retention of an independent consultant to ensure remediation of material weaknesses, including those involving related party transactions.  
• Lifeway Foods Inc. disclosed material weaknesses in each of its Forms 10-K for a period of nine years, from 2007 through 2015, and significant deficiencies that in the aggregate constituted a material weakness in 2016. In both 2013 and 2014, company management failed to complete the required ICFR evaluation. Lifeway did not fully remediate its material weaknesses and conclude that ICFR was effective until its fiscal year ended December 31, 2017. Lifeway’s failure to address its material weaknesses was compounded by three announced restatements since fiscal 2012, including two restatements announced during fiscal 2016. The Commission’s settled order includes violations of Exchange Act Sections 13(a), 13(b)(2)(A), 13(b)(2)(B), and Rules 13a-1, 13a-15(a) and 13a-15(c), thereunder, and payment of a $100,000 civil penalty.
• Digital Turbine Inc. disclosed material weaknesses in each of its Forms 10-K over a period of seven years, from fiscal year 2011 through fiscal year 2017. The company did not fully remediate its material weaknesses until the end of fiscal year 2018, as disclosed in its Form 10-K for the year ended March 31, 2018. The Commission’s settled order includes violations of Exchange Act Section 13(b)(2)(B) and Rule 13a-15(a), thereunder, and payment of a $100,000 civil penalty.  
• CytoDyn Inc. disclosed material weaknesses in each of its Forms 10-K over a period of nine years, from 2008 through 2016. CytoDyn included in its public filings the same, nearly boilerplate, disclosure of material weaknesses for nine consecutive years. CytoDyn remediated its material weaknesses and determined that ICFR was effective as of May 31, 2017. The Commission’s settled order includes violations of Exchange Act Section 13(b)(2)(B) and Rule 13a-15(a), thereunder, and payment of a $35,000 civil penalty.  

The SEC’s investigation was conducted by members of the Division of Enforcement’s Financial Reporting and Audit Group (FRAud Group) including John Archfield, Yolanda Lavery, Tonya Tullis, and Juan Migone, and supervised by Margaret McGuire, Chief of the FRAud Group, and Ms. Hodgman. 

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SEC Names Manisha Kimmel as Senior Policy Advisor to the Chairman on the Consolidated Audit Trail

The Securities and Exchange Commission today announced that Manisha Kimmel will serve as Senior Policy Advisor for Regulatory Reporting to Chairman Jay Clayton.  In this new role, Ms. Kimmel will coordinate the SEC’s oversight of the self-regulatory organizations’ (SROs) creation and implementation of the Consolidated Audit Trail (CAT).  Ms. Kimmel will work closely with the Division of Trading and Markets and other divisions and offices on the CAT and other regulatory reporting matters.

In the wake of the 2010 “Flash Crash,” the Commission adopted a rule that requires the national securities exchanges and FINRA (collectively, the SROs) to work together to develop and submit to the SEC a plan to create, implement and maintain a CAT.  The CAT is designed to provide a single, comprehensive database that, when fully implemented, will allow regulators to more efficiently and accurately track trading in equities and options throughout the U.S. markets.  The CAT is intended to, among other things, allow the Commission to better carry out its oversight responsibility by improving its ability to reconstruct trading activity following a market disruption or other event, which in turn would allow the Commission to more quickly understand the causes of such an event and respond appropriately.

“Manisha knows the value of orderly, deep, and transparent markets to our investors and our country, and I am grateful that she has decided to take on this new, important role,” said Chairman Jay Clayton.  “I am confident that her extensive experience and expertise in market data and regulatory reporting will further enhance the Commission’s ability to effectively oversee the SROs’ implementation of the CAT.”  

“I am honored to have been chosen by the Chairman to advise him on matters related to the SROs’ implementation of the CAT, and I look forward to working with the SEC’s talented staff on these important topics,” said Ms. Kimmel.  

Kimmel joins the SEC from Refinitiv, where she served as Head of Regulatory and Compliance, Wealth Management.  In addition to her role at Refinitiv, Ms. Kimmel served on the Advisory Committee for CAT NMS LLC, a diverse group of industry experts that offers advice to SROs on technical specifications, reporting functionality, and other matters relating to the CAT.  She has previously been a member of the SEC’s Equity Market Structure Advisory Committee (EMSAC).  Prior to her time at Refinitiv, Ms. Kimmel served as Managing Director of the Financial Information Forum, where she worked with broker dealers, exchanges, and vendors on issues involving regulatory and market data technology issues.  She has also held positions at Jordan & Jordan and Automatic Data Processing. Ms. Kimmel earned her B.S. in Economics from the Wharton School of Business at the University of Pennsylvania and her B.S. in Engineering from Penn’s School of Engineering and Applied Sciences.

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Shamoil T. Shipchandler, Regional Director of the SEC’s Fort Worth Regional Office, Has Left the Agency

The Securities and Exchange Commission today announced that Shamoil T. Shipchandler, Director of the Fort Worth Regional Office, left the agency on Friday, January 25.  Under Mr. Shipchandler’s leadership, the Fort Worth office has brought numerous significant enforcement actions and has conducted examination activities that have strengthened compliance in the industry, including filing novel cases involving accounting fraud and cryptocurrency, and providing transparency to regional registrants.

Since 2015, Mr. Shipchandler has led a team of approximately 140 enforcement attorneys, accountants, investigators, and compliance examiners who investigate and enforce the federal securities laws and perform compliance inspections in the Fort Worth region, which includes Texas, Oklahoma, Arkansas, and Kansas.  The region has over 1,000 registered investment advisers and broker-dealers with over $2 trillion of assets under management.

“Shamoil approached his public service with passion, commitment, and flair, and always with the interests of our investors in mind,” said SEC Chairman Jay Clayton. “The Fort Worth office made significant contributions to both the Enforcement and Examination programs under his leadership and I thank him for his service to the agency.”  

“Shamoil’s leadership and thoughtful approach to new and complex issues has served the Commission and the investing public well,” said Stephanie Avakian, Co-Director of the SEC’s Division of Enforcement.  “He has led Fort Worth’s enforcement program in investigating and prosecuting an array of complex matters, and we will miss him.”

“Shamoil is an exceptional attorney and dedicated public servant,” said Steven Peikin, Co-Director of the SEC’s Division of Enforcement.  “As head of the SEC’s Fort Worth office, he has grown the office’s expertise, spearheaded significant initiatives, and led the office to having a tremendous impact in the region.”

“Shamoil has been a tireless advocate for investors during his time in the Fort Worth Regional Office,” said Pete Driscoll, Director of the SEC’s Office of Compliance Inspections and Examinations (OCIE).  “His innovative investor outreach and leadership greatly contributed to the advancement of OCIE’s mission.”

Mr. Shipchandler said, “It has been an extraordinary honor to work with such talented public servants who have dedicated their lives to protecting investors and strengthening our financial markets.  The SEC’s Fort Worth staff has built a culture that is thoughtful and innovative in its approach to a wide variety of important issues, and respected for its commitment to excellence and integrity.”

During Mr. Shipchandler’s tenure as Regional Director, the Fort Worth office has brought many significant enforcement actions that have benefitted retail investors, including charges against:

• AriseBank and its co-founders, for operating an allegedly fraudulent Initial Coin Offering (ICO) to fund what it claimed to be the world’s first “decentralized bank,” in which the SEC sought the appointment of a receiver, for the first time, in connection with an ICO fraud to preserve investor funds
• KBR, for inflating a key, non-financial statement performance metric in disclosures to investors
• Three former BDO accountants, for improperly “predating” their audit work papers
• Christopher Faulkner and Breitling, for defrauding investors through a multi-faceted $80 million oil-and-gas related scheme
• 1Broker, in a coordinated action with multiple other federal regulators, for allegedly violating the federal securities laws in connection with security-based swaps funded with bitcoins
• Two real estate investment funds operated by United Development Funding and their executives, for misleading investors about the use of funds as well as committing GAAP violations
• Investment adviser Ash Narayan, who secretly siphoned millions of dollars from client accounts he managed for professional athletes

During Mr. Shipchandler’s tenure, the SEC’s National Examination Program staff in Fort Worth increased examinations of investment advisers and broker-dealers and expanded the use of data analytics and its risk-based approach to examinations.  Mr. Shipchandler also engaged in outreach to provide insight to registrants concerning common deficiencies. 

Before joining the SEC, Mr. Shipchandler was Deputy Chief of the Criminal Division of the U.S. Attorney’s Office for the Eastern District of Texas.  Mr. Shipchandler was a partner at Bracewell LLP and, before joining the U.S. Attorney’s Office, he was associated with Covington & Burling LLP.  Mr. Shipchandler graduated from Middlebury College and Cornell Law School, and clerked for Judge Roger B. Andewelt of the U.S. Court of Federal Claims.  Mr. Shipchandler also is an adjunct faculty member of the SMU Dedman School of Law, where he teaches courses in Data Privacy and Cybersecurity Law and White Collar Crime.

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Court Orders $1 Billion Judgment Against Operators of Woodbridge Ponzi Scheme Targeting Retail Investors

The Securities and Exchange Commission today announced that a federal court in Florida ordered Woodbridge Group of Companies LLC and its former owner to pay $1 billion in penalties and disgorgement for operating a Ponzi scheme that targeted retail investors.

The Honorable Judge Marcia G. Cooke of the U.S. District Court for the Southern District of Florida approved judgments against Woodbridge and its 281 related companies ordering them to pay $892 million in disgorgement. The court ordered former owner and CEO Robert H. Shapiro to pay a $100 million civil penalty and to disgorge $18.5 million in ill-gotten gains plus $2.1 million in prejudgment interest.

In December 2017, the SEC filed an emergency action charging the company and other defendants with operating a massive $1.2 billion Ponzi scheme that defrauded 8,400 retail investors nationwide, many of them seniors who had invested retirement funds. The SEC's complaint alleged that Shapiro made Ponzi payments to investors and used a web of shell companies to conceal the scheme.

"This resolution accomplishes one of the SEC's core missions to protect retail investors," said Stephanie Avakian, Co-Director of the SEC's Division of Enforcement. "Mr. Shapiro and other defendants will be held accountable and required to pay substantial penalties for their misconduct."

"Our complaint charged that when Woodbridge's fictitious business model collapsed, the company stopped paying investors and filed for Chapter 11 bankruptcy protection," said Eric I. Bustillo, Director of the SEC's Miami Regional Office. "The settlement provides for the return of significant funds to investors."

The court's disgorgement order against Woodbridge and related corporate defendants will be deemed satisfied by a Liquidation Trust being formed under a plan in the Woodbridge Chapter 11 case in the U.S. District Court for the District of Delaware (Case No. 17-12560-KJC). The Liquidation Trust will be obligated to make distributions of net proceeds from the disposition of the defendants’ assets in bankruptcy. The amount to be distributed will depend upon the amounts collected by the Liquidation Trust.

All defendants and relief defendants, without admitting or denying the SEC's allegations, consented to the entry of final judgments which also permanently prohibit the defendants from violating the antifraud and other provisions of the federal securities laws.

RS Protection Trust and several relief defendants were collectively ordered to pay $5.3 million in ill-gotten gains and interest. Shapiro also consented to the entry of an SEC administrative order, without admitting or denying the SEC's findings, permanently barring Shapiro from association with any broker, dealer, investment adviser, municipal securities dealer, municipal advisor, transfer agent, or nationally recognized statistical rating organization, and from participating in any offering of a penny stock.

The SEC's litigation has been led by Russell Koonin, Christine Nestor, Scott A. Lowry and David W. Baddley, and has been supervised by Andrew O. Schiff in the Miami Regional Office. The SEC's continuing investigation is being conducted by Mr. Lowry, Ms. Nestor, Mr. Koonin and Mark Dee, and supervised by Jason R. Berkowitz and Fernando Torres.

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SEC Emergency Action Charges Texas Real Estate Developer for Multi-Million Dollar Offering Fraud

The Securities and Exchange Commission announced today that it filed charges against Texas resident and real estate developer Phillip Michael Carter, two other individuals, and several related entities for conducting a multi-million dollar offering fraud.  

The SEC's complaint alleges that Carter, along with Bobby Eugene Guess and Richard Tilford, raised almost $45 million from over 270 investors across the United States by selling short-term, high-yield promissory notes issued by a number of shell companies intentionally named to confuse investors.  The complaint alleges that Carter, Guess, and Tilford claimed to offer investments in Carter's legitimate real estate development companies, which were purportedly backed by hard assets from actual real estate development projects.  Instead, the complaint alleges, the individual defendants sold securities issued by unrelated, but closely-named, entities that had no assets.  Carter then misappropriated investor funds to pay $1.2 million towards a personal IRS tax lien, operate a luxury hunting ranch, fund his lifestyle, and make over $3 million in Ponzi payments to investors.  

"Phillip Carter and his co-defendants lied about the nature of their investments and enriched themselves at their investors' expense," said Shamoil T. Shipchandler, Director of the SEC's Fort Worth Regional Office, whose last day at the Commission is today. 

The complaint, filed in federal court in Dallas, charges the defendants with violating the anti-fraud provisions of the Securities Act and Exchange Act, participating in the unregistered offer and sale of securities, and functioning as unlicensed brokers, and seeks permanent injunctions, conduct-based injunctions, disgorgement with prejudgment interest, and civil penalties.  The complaint also charges four entities as relief defendants, seeking disgorgement and prejudgment interest.  Finally, the SEC's complaint seeks an asset freeze, accounting, and document preservation order over Carter and several entities to protect and preserve assets for the benefit of investors. 

In related criminal proceedings pursued by the Texas State Securities Board, Carter and Tilford were indicted on November 6, 2018, for, among other things, securities fraud, sales of unregistered securities, and sales of securities by an unregistered agent or dealer. Those charges remain pending.

The SEC's investigation was conducted by Jason A. Braun and Michelle Lama, and supervised by Jim Etri, B. David Fraser, and Eric R. Werner.  The litigation is being conducted by Matt Gulde.  The SEC acknowledges the assistance and cooperation of the Texas State Securities Board. 
 

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SEC Brings Charges in Edgar Hacking Case

The Securities and Exchange Commission today announced charges against nine defendants for participating in a previously disclosed scheme to hack into the SEC’s EDGAR system and extract nonpublic information to use for illegal trading. The SEC charged a Ukrainian hacker, six individual traders in California, Ukraine, and Russia, and two entities. The hacker and some of the traders were also involved in a similar scheme to hack into newswire services and trade on information that had not yet been released to the public. The SEC charged the hacker and other traders for that conduct in 2015 (see here, here and here).

The SEC’s complaint alleges that after hacking the newswire services, Ukrainian hacker Oleksandr Ieremenko turned his attention to EDGAR and, using deceptive hacking techniques, gained access in 2016. Ieremenko extracted EDGAR files containing nonpublic earnings results. The information was passed to individuals who used it to trade in the narrow window between when the files were extracted from SEC systems and when the companies released the information to the public. In total, the traders traded before at least 157 earnings releases from May to October 2016 and generated at least $4.1 million in illegal profits.

“International computer hacking schemes like the one we charged today pose an ever-present risk to organizations that possess valuable information,” said Enforcement Division Co-Director Stephanie Avakian. “Today’s action shows the SEC’s commitment and ability to unravel these schemes and identify the perpetrators even when they operate from outside our borders.”

“The trader defendants charged today are alleged to have taken multiple steps to conceal their fraud, including using an offshore entity and nominee accounts to place trades,” said Enforcement Division Co-Director Steven Peikin. “Our staff’s sophisticated analysis of the defendants’ trading exposed the common element behind their success, providing overwhelming evidence that each of them traded based on information hacked from EDGAR.”

The SEC’s complaint alleges that Ieremenko circumvented EDGAR controls that require user authentication and then navigated within the EDGAR system. Ieremenko obtained nonpublic “test files,” which issuers can elect to submit in advance of making their official filings to help make sure EDGAR will process the filings as intended. Issuers sometimes elected to include nonpublic information in test filings, such as actual quarterly earnings results not yet released to the public. Ieremenko extracted nonpublic test files from SEC servers, and then passed the information to different groups of traders.

The SEC’s complaint alleges that the following traders received and traded on the basis of the hacked EDGAR information:

• Sungjin Cho, Los Angeles, California
• David Kwon, Los Angeles, California
• Igor Sabodakha, Ukraine
• Victoria Vorochek, Ukraine
• Ivan Olefir, Ukraine
• Andrey Sarafanov, Russia
• Capyield Systems, Ltd. (owned by Olefir)
• Spirit Trade Ltd.

In a parallel action, the U.S. Attorney’s Office for the District of New Jersey today announced related criminal charges.

The SEC’s complaint charges each of the defendants with violating the federal securities antifraud laws and related SEC antifraud rules and seeks a final judgment ordering the defendants to pay penalties, return their ill-gotten gains with prejudgment interest, and enjoining them from committing future violations of the antifraud laws. The SEC also named and is seeking relief from four relief defendants who profited from the scheme when defendants used the relief defendants’ brokerage accounts to place illicit trades.

The SEC’s investigation, which is ongoing, was conducted by Market Abuse Unit and Cyber Unit staff David Bennett, Arsen Ablaev, Michael Baker, Jason Burt, Laura D’Allaird, Adam Gottlieb, James Scoggins, David Snyder, Jonathan Warner, Darren Boerner, and John Rymas, and IT Forensics staff Ken Zavos, Douglas Bond, Stephen Haupt, Gi Nguyen, and Jennifer Ross. The Division of Economic and Risk Analysis and the Office of Information Technology provided substantial assistance. The investigation was supervised by Robert Cohen, Joseph Sansone, and Carolyn Welshhans. Cheryl Crumpton and Stephan Schlegelmilch are leading the SEC’s litigation. The SEC appreciates the assistance of the U.S. Attorney’s Office for the District of New Jersey, the Federal Bureau of Investigation, and the U.S. Secret Service.

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