Specific
Cases
______
I
believe that a review of specific cases will assist you in
discovering where the boundaries are in Section 17(b).
The
1998 SEC Crack Down_______________________________________________
In
a 1998 crack down on Internet Stock Fraud, the SEC announced
23 enforcement actions against 44 individuals and companies for
committing fraud over the Internet. All of the cases involve
alleged illegal touting of securities in violation of Section 17(b)
of the 1933 Securities Act. In all of these cases, the Internet
promoters gave ostensibly independent opinions about Microcap
companies that in reality were bought and paid for. Not only did they
lie about their own independence, some of them lied about the
companies they featured, then took advantage of any quick spike in
price to sell their shares for a fast and easy profit.
The
23 cases involve a range of Internet conduct including fraudulent
spams (Internet junk mail), online newsletters, message board
postings and Web sites. The allegations include violations of the
anti-fraud provisions and the anti-touting provisions of the federal
securities laws. The authors of the spams, online newsletters,
message board postings and Web sites unlawfully touted more than 235
Microcap companies, by either: (1) lying about the companies; (2)
lying about their own "independence" from the companies;
and/or (3) failing to disclose adequately the nature, source and
amount of compensation paid by the companies. The creators of the
Internet touts purported to provide unbiased opinions in their
recommendations, but failed to disclose that they had received in
total more than $6.3 million and nearly two million shares of cheap
insider stock and options in exchange for touting services. In some
instances, the fraudsters sold their stock or exercised their options
immediately following their recommendations, a deceptive practice
commonly referred to as "scalping."
All
twenty-three cases involve allegations of illegal touting of
securities under Section 17(b) of the Securities Act of 1933. The SEC
said that 17(b) provides that it is unlawful to publicize a security,
if you are being paid to do so, unless you disclose three things. The
first thing that is required to be disclosed is nature of the
compensation you are receiving, whether it is cash, or whether it is
stock. The second is the amount of compensation you are
receiving. The third is the source of the compensation.
The
SEC added that, "17(b) does not prohibit free speech. It
does not prohibit spamming, online newsletters, posting on message
boards, without other activity as well. But lying to investors,
or failing to disclose compensation, does violate the law."
The
SEC featured the case of
SEC
v. The Future Superstock, Inc. and Jeffrey Bruss,
(U.S.D.C., N.D.Ill., Case No. 98-C-6772, filed October 27,
1998.) In this case the SEC sought a permanent injunction,
disgorgement,
civil penalties and other relief against The Future Superstock, Inc.
(FSS) and Jeffrey Bruss. The complaint alleged that an Internet
newsletter called The Future Superstock, is published by FSS and
researched and written by Bruss. It further alleged that the
newsletter and website have recommended to the over 100,000
subscribers that they purchase about 25 microcap stocks which it
predicted would double or triple in the next three to twelve months.
In most instances, the prices increased for a short period of time
after a recommendation was made, but then dropped substantially.
The
complaint also alleged that FSS and Bruss violated federal securities
laws by failing to provide adequate disclosure in several areas: (1)
neither the newsletter nor the website disclosed that Bruss or FSS
received compensation, in cash and stock, from nearly every issuer
profiled; (2) FSS and Bruss failed to disclose that in many instances
they sold the stock shortly after a recommendation in The Future
Superstock caused its price to rise; (3) FSS and Bruss represented
that they performed independent research and analysis when, in fact,
little, if any, research was conducted; and (4) statements regarding
the success of past stock picks made in The Future Superstock were
false and misleading. The complaint alleges that FSS and Bruss
have violated Sections 17(a) and 17(b) of the Securities Act of 1933
and 10(b) of the Securities Act of 1934 and Rule 10b-5.
All
of the cases in the SEC sweep had a common thread. They all
alleged fraudulent touting of securities, which violate Section 17(b)
of the 1933 Act.
Section
17(b) provides that it is unlawful to publicize a security, if you
are being paid to do so, unless you disclose three things. The
first thing that is required to be disclosed is nature of the
compensation you are receiving, whether it is cash, or whether it is
stock. The second is the amount of compensation you are
receiving. The third is the source of the compensation.
The
SEC noted that 17(b) does not prohibit free speech, that it does not
prohibit spamming, online newsletters, posting on message boards,
without other activity as well. However, lying to investors, or
failing to disclose compensation, does violate the law.
The
SEC went on to note that Section 17(b) applies to any person who
publicizes a security through any means. When it comes to the
Internet, that includes publicizing securities over World Wide Web
pages, online investment newsletters, bulletin boards, chat rooms, or
through Internet junk mail, which is popularly known as spam.
Section
17(b) is important because investors have a right to know if
information is objective, or whether someone is paying to provide
that information to investors.
There
is nothing illegal about companies paying fees to touters. The
law requires the touters have to disclose. The law does not cover the
companies themselves who make the payments.
Five
of the cases involved the practice known as scalping. Scalping
occurs when, unbeknownst to investors, a person making a positive
recommendation about a security, sells that security shortly after
making the positive recommendation, without making a disclosure to
other people.
Six
of the cases involved misrepresentation, either about the companies
themselves, or about the touter's independence and track record.
All
of the cases involved either partial disclosure, or no disclosure at
all, about the nature and source of the compensation received.
In
the 1998 Crack Down the question was asked as to what kind of
penalties do the scammers face in the cases that were filed. The SEC
replied that many of cases will be litigated cases and penalties will
be up to a court, or an administrative law judge. In these cases, the
SEC sought injunctive relief, to enjoin people from violating the
law, cease and desist orders, and penalties where appropriate. The
SEC stated that there were going to be a wide range of different
penalties, depending on the conduct involved. No dollar figures were
given.
In
the Matter of John
Black_______________________________________________
In
this case, an employee of an investor relations firm touted stock on
an Internet bulletin board, Raging Bull, without disclosing that he
was being compensated for the posts by his employer. He failed to
disclose that he was promised thousands of shares of stock as a bonus
for assisting his employer in promoting the stock of Snelling Travel,
Inc. ("SNLV").
On
December 30, 1999, Black started a subject area for SNLV on Raging
Bull, an Internet bulletin board. Using a screen name other than his
own, Black posted the first message in the SNLV subject area. Black's
message compared SNLV to two highly successful companies that sell
electronic commerce software applications, Commerce Once, Inc.
("CMRC") and Ariba Technologies ("ARBA"). Black's
message stated:
This
is THE new CMRC and ARBA!!! Merger to be complete on Jan. 6. This
baby is going to rock!!! I hear they are looking for $30.00 by Mar.
15!!! We will just have to wait and see!!! The sky is the limit!!!
Black
did not disclose his agreement with Fleming Financial, which entitled
to him to receive 5,000 shares of SNLV as reimbursement for promoting
SNLV.
On
December 31, 1999, Black posted a second message in the SNLV subject
area, using a different screen name. Black's message stated:
When
will the company finish the merger? How many shares are out? What are
the similarities between Plus Solutions and ARBA and CMRC? When will
they be "in the money"? These are questions that MUST be
answered by somebody! Anybody know a # to call?
As
in the first message, Black did not disclose that he was entitled to
receive remuneration for touting SNLV.
The
SEC cited two other cases of posting on message boards without
complying with 17(b): In the Matter of David A. Wood, Jr. et
al., 68 SEC Docket 631 (Oct. 27,1998) (respondent violated
Section 17(b) by posting messages on Internet message board touting
company without disclosing compensation received) and In the
Matter of Eugene B. Martineau, 68 SEC Docket 629 (Oct. 27, 1998)
(respondent violated Section 17(b) by posting messages on Internet
message board touting company without disclosing expected
compensation).
Black
committed or caused violations of Section 17(b) by failing to
disclose the agreement to receive, indirectly from the issuer,
compensation for touting SNLV stock.
No
mention was made by the SEC as to the legal significance of Black
using another user name on the chat site. Would this be another 17(b)
violation even if he had used given the disclosure as to the source
and amount of compensation? Could it be fraud to use a false user
name?
Donner
Case____________________________________________________________
Donner
was a broker dealer that issued 48 research reports of stocks below
$5.00. This was 70% of Donner's business.
Under
a typical agreement between Donner and an issuer, Donner received an
initial retainer fee of $2,500, $2,000 per month for
services provided, and $2 to $3 for each investor package mailed to
potential investors. Some agreements also provided that Donner would
receive stock if the company's share price exceeded a certain level
after Donner initiated coverage of the company. One of the individual
defendants, Uberti, testified that, he received fifty percent of the
amounts generated by [Donner's] relationship with the company.
For
FINRA members, 17(b) violations are also violations of FINRA rules.
The
reports simply stated that Donner "may from time to time perform
investment banking, corporate finance, provide services for, and
solicit investment banking, corporate finance or other business "
from the company. Several of these reports added the words "for
a fee" after this description of services.
The
record established that Donnor violated Rule 17(b) by failing to
disclose the compensation received by Donner in violation of
Securities Act Section 17(b).
In
order to violated section 17 B, a person must use a means of
interstate commerce, to make a communication which describes a
security, for consideration received, without full disclosure of the
consideration received in the full amount. The consideration can be
past, current, or prospective, and it can be direct or indirect
consideration. Section 17(b) was designed to protect the public from
publications that purport to give an unbiased opinion but which
opinions and reality are bought and paid for.
The
SEC pointed out that the Donnor research reports stated only that
Donner "may from time to time perform investment banking,
corporate finance, or provide services for the issuer” sometimes
adding that Donner might perform the services for a fee. They did not
disclose that Donnor in fact received compensation in exchange for
writing and making public the research reports and for the type of
consideration of the amount of compensation received.
Gorsek_________________________________________________________________
Gorsek
was a Federal Court decision. In
Gorsek, the Court found that the disclaimer was inadequate as is
insufficient under Rule 17(b) because although it gave the fact that
there was compensation, it failed to list the amount of compensation
and the type of consideration (e.g. stock,
cash, or combination of cash and stock).
Other
SEC Cases________________________________________________________
In
an SEC complaint against Christopher Wheeler and his
OTCstockexchange.com, the SEC alleged a pump and dump scheme
orchestrated by Wheeler involving securities of several thinly traded
penny stocks. Wheeler recommended investors purchase the securities
without disclosing that he had received millions in shares as
compensation for his promotions and was simultaneously liquidating
the shares. In total he profited at least $2.95 million.
At
various times during 2007 and 2008, Wheeler used the website to
promote the issuer stock in return for undisclosed compensation in
the form of millions of shares. Wheeler featured the issuer stock in
the website and posted lofty price targets for the stock without any
reasonable basis for those targets. These promotional efforts often
resulted in dramatic, but temporary, increases in the volume of
shares traded in the price of the issuer securities. These temporary
increases in volume and trading allowed Wheeler to sell the shares in
the issuers for a large profit, totaling approximately $2.95 million.
Wheeler
and the website failed to disclose in each instance that Wheeler had
received stock, directly or indirectly from the Issuers as
compensation for his promotional efforts were the amount of stock he
received in compensation, as required under the federal securities
laws. Instead, the website contained a representation that its was
compensated by one or more third parties on behalf of the companies
listed, followed by a list of several companies and the websites'
compensation arrangement with those companies. During the relevant
period this never included the issuers. Website thereby falsely
represented that Wheeler had received no compensation for its
promotional activities with respect to the issuer in question.
Wheeler
and the website also concealed from investors that Wheeler was
personally selling shares in the issuers' stock while he was
promoting the same stock in recommending that investors buy it. The
website contained only general disclosure that the site may at any
time have positions in the securities mentioned and may make
purchases or sales in the securities featured on the website and may
sell its shares. The SEC complained that Wheeler and the website
never disclosed that in each instance Wheeler was reselling the
issuer stock.
During
the relevant period Wheeler the website never disclosed it really
received shares as compensation for the promotion, and the amount of
such compensation, or that Wheeler was selling stock while
recommending the stock is a buy.
Wall
Street Bulletin
In
another complaint, the SEC said that a penny stock promoter named
Gregory King crafted false and misleading tout sheets crafted to
appear like independent investment newsletters and entitled them the
Wall Street Bulletin. A spam campaign consisting of faxes was
maintained.
The
Wall Street Bulletin failed to disclose the amount of the
compensation. Shares were paid to the defendant to prepare and
disseminate these "Newsletters." Further, the defendants
were selling stock contrary to the Wall Street Bulletin's strong buy
recommendations and price targets.
The
promoters misleadingly represented that the Wall Street Bulletin was
paid by an unnamed third party, that the Wall Street Bulletin was
based on independent research, that the Wall Street Bulletin and its
employees had not and would not receive any and shares and that the
Wall Street Bulletin and its employees would not buy or sell any and
stock. These were false and misleading representations and/or
omissions.
The
SEC alleged that the defendants knew or were reckless in not knowing
that the Wall Street Bulletin failed to disclose that shares had been
paid to make the promotion.
Investment
Advisor
In
a case involving an investment advisor, the SEC alleged that the
investment advisor solicited his advisory clients to invest in real
estate developments after being promised compensation for raising
investor money and promised title to a 5,000 square foot home. He
did not disclose to his advisory clients or other investors this
conflict of interest, namely that he had been promised compensation
for fund raising efforts.
SEC
v. Investsource
In
the case of SEC v. Investsource, Inc. et al, the SEC alleged
that in 2008 and 2009 defendants engaged in massive e-mail campaigns
to promote penny stocks of their clients often sending such e-mails
to hundreds of thousands of recipients.
These
emails failed to disclose that defendants have been compensated for
their promotions. Further defendants made misleading statements on
Investsource's website regarding the nature the compensation received
for investors providing services to its penny stock issuer clients.
Finally, both the e-mail thousand websites failed to disclose that
defendants reselling the very securities they were recommending that
investors buy.
Invest
source was a penny stock website. From January 2008 and March 2009
Invest source had 85 clients, almost all penny stock issuers. was
client stated securities cash. Investor sent is daily digest e-mails
to addresses in its database nearly every weekday. By the Autumn of
2008 Invest source was routinely sending messages to several hundred
thousand addresses.
Undisclosed
to the e-mail letter recipients, Investsource and its principal
repeatedly sold the stock of the issuer it promoted while engaged in
the promotional activities. They did not disclose the compensation
received in their securities trading in any of the e-mail
newsletters. Instead each e-mail included the a disclaimer link to
their website. The link took investors to their "Main
Disclaimer" website page which stated in relevant part:
The
companies listed on the 'Featured Companies' section of our website
may have compensated the Company [InvestSource] to be profiled on
this website. These companies (or some of these companies) have
retained us to perform public relations, or media relations or even
investor relation services including promotional services that
consist of the placement of the profiled companies on our website.
Such compensation has been or will be made in cash and or [sic]
issuance of securities of the profiled company. The specific
compensation type and amounts that the company has been paid from
each respective company is set forth on the transcript box
accessible from each respective company page within our site. We may
liquidate any securities that we receive as compensation when deemed
appropriate to do so, however, we attempt to liquidate such
securities upon receipt thereof prior to performing any services for
such company. Such liquidation may have a negative impact on the
securities being liquidated.
The
SEC attacked the disclaimer sections stating that the companies may
have compensated the website, that such compensation will be made in
cash or securities, and that the website attempted to liquidate such
securities upon receipt thereof part of performing any services for
such company.
In
fact, Investsource or its principal were always compensated.
Investsource claimed in its disclaimers that it attempted to
liquidate securities it received as compensation for services upon
receipt thereof prior to performing any services. In fact, it sold
the securities after several recommending their purchase and profited
thereby. The statement that Investsource planned to sell securities
before promoting them was materially false because its practice was
to sell securities while promoting them.
Their
website contained additional disclosure. Each of the client companies
had a profile sections that included many tabs from which to select.
One of these tabs was labeled “disclaimer.”
The
SEC found that these company-specific disclaimers were inadequate.
When the defendants were contacted by the SEC during the SEC's
investigation, they revised the company-specific disclaimer website
pages to list the number of shares sold and the amount of sales
proceeds.
However,
they still failed to disclose that they were continuing to sell the
securities while promoting them. The defendants similarly failed to
correct the main disclaimer website page to adequately disclose that
defendants were always compensated for promoting the securities, that
the compensation was almost always in securities, and that defendants
promoted the purchase of the stock to potential buyers before, during
and after their sales of those same stocks.
Thus,
it was not enough that the defendants stated that they may be
compensated where they were actually always compensated. Further,
they did not state that they would be selling the stock they received
before, during and after their promotional campaigns.
SEC
v. Shrewder et al____________________________________________________
In
this case the SEC alleged that the defendants manipulated the market
in at least two securities and inundated the public with millions of
faxes or "fax blasts" that contained materially false
information in order to mislead people into buying the stocks
described.
The
faxes in question were alleged to be from the bioTech Report and
contained identical disclaimers that they had been contracted by a
"third party” to research and issue the report and that the
publication expected to receive $30,000 to distribute the report.
The
SEC alleged that the bioTech Report is a pseudonym used to mask the
fact that the defendants were paid by the company for the promotional
campaign and the publication is not an independent investor awareness
publication is stated in the faxes.
The
disclaimer misrepresented the compensation that the defendants
received, the fact that they had already received as compensation,
and the fact that their services had been contracted by an agent of
the company and not a third-party.
The
SEC also alleged that the faxes failed to disclose and that Shrewder
was actively selling the shares while he was recommending that
investors include accumulate the shares. Shrewder also engaged in day
trading to falsely create the appearance of trading volume during his
fax blasting campaign. Shrewder also engaged in scalping. He sold
into the rising price and increase in volume caused in whole or in
part by his faxes and his manipulative trading, which the SEC said is
a practice commonly known as scalping.
Shrewder
also manipulated other stocks. He used a pseudonym for the publisher
of this fax, this time the US Oil Reporter, misleadingly stating that
it is an independent investor awareness publication.
As
with the other faxes that Shrewder disseminated he misrepresented the
compensation he received from promoting a stock in a disclosure
statement of the factors stated that this entity is "is expected
to receive $25,000 to issue this report on [the stock]. . . .”
In
fact Shrewder had already received 260,000 shares of stock with a
value at the time of $0.91 for a total of $236,000. The market value
of the stock received at the time he sent the fax blast was
approximately $226,000 far more than the $25,000 stated in the
disclosures. He engaged in day trading and he recommended
accumulating the stock up to $2.00 and exiting the stock at $5.00. As
with the other stock, he sold this stock at far less than the price
he was recommending in his faxes.
SEC
v. Courtney D. Smith
In
SEC
v. Courtney D. Smith,
the defendant received cash and stock to promote the company’s
stock. He promoted the stock a number of times on television. At one
time he on TV he stated that he had a big chunk of stock and thought
it was worth twice the current market price. This was misleading as
the impression was that he had purchased the stock when in fact it
had been given to him for stock promotion.
