SEC Sues and Settles Claim Against Investment Adviser Representative For “Cherry-Picking Scheme” After Entry of Cease and Desist Order Against the Investment Adviser

SEC Sues and Settles Claim Against Investment Adviser Representative For “Cherry-Picking Scheme” After Entry of Cease and Desist Order Against the Investment Adviser

On September 13, 2022, the Securities and Exchange Commission (“SEC”) announced a settlement with investment advisory firm Buckman Advisory Group LLC (“Buckman Advisory”) and its CEO Harry Buckman Jr. to settle claims related to an alleged cherry-picking scheme conducted by a former Buckman employee Scott Brander the day after the SEC filed a complaint against Brander in the U.S. District Court for the District of New Jersey.

The SEC alleged that from 2012 to 2017, Brander operated a “cherry-picking” scheme whereby he preferentially allocated profitable trades to himself and unprofitable trades to his clients’ discretionary accounts – thus enriching himself at the expense of the clients – in violation of Section 17(a)(1) of the Securities Act, Section 10(b) of the Securities Exchange Act and Rule 10b-5 thereunder, and Sections 206(1) and 206(2) of the Investment Advisers Act (“IAA”). According to the SEC, Brander did so by initiating trades in highly-leveraged and risky exchange traded funds (“ETFs”), but did not allocate those trades until after he determined whether they were profitable hours later, in in some cases on the following day. By delaying the allocation, the SEC charged that he was able to allocate 90% of the profitable trades to his own accounts, and therefore only 10% to his clients’ accounts. He similarly allocated only 30% of the unprofitable trades to himself, leaving 70% of what that the SEC termed “losing trades” to his clients. The Commission further alleged that Brander engaged in ETF trading on behalf of clients who had requested more conservative investment options, without any assessment of whether these risky transactions were appropriate. Without admitting or denying the allegations, Brander consented to the entry of a judgment that permanently enjoins him from further violations and orders him to pay disgorgement of $812,876 in allegedly ill-gotten gains, prejudgment interest of $169,089.83, and a civil penalty of $200,000. The entry of the judgment is subject to the court’s approval.

The SEC also instituted and settled a related administrative proceeding against Buckman Advisory (the registered investment adviser that employed Brander) and the firm’s CEO Henry Buckman, Jr. (who was Brander’s direct supervisor), based on failures to implement policies and procedures reasonably designed to prevent violations of the IAA and their failure to supervise Brander. Without admitting or denying the SEC’s findings, both defendants agreed to the entry of cease-and-desist orders. The firm agreed to a censure, a penalty of $400,000, and an undertaking to retain and adopt the recommendations of an independent compliance consultant. Buckman agreed to a penalty of $75,000 and a limitation on acting in a supervisory capacity for twelve months.

SEC Initiates Enforcement Action Against Underwriter for Alleged Municipal Bond Disclosure Violations in Hundreds of Offerings

On September 13, 2022, the SEC filed suit in the U.S. District Court for the Southern District of New York against Oppenheimer & Co., alleging that Oppenheimer claimed exemption from providing financial disclosures to bond investors in “at least 354” offerings that the SEC contends did not meet the requirements for the exemption. This action is one of the SEC’s first-ever enforcement actions against an underwriter that allegedly skirted around certain municipal bond disclosure requirements.

Municipalities offering securities to raise funds for public projects are generally exempt from the standard registration and reporting provisions imposed by the federal securities laws. Instead, Rule 15c2-12 of the Exchange Act indirectly imposes disclosure requirements on municipal issuers through their underwriters who are required to provide continuous updates on bonds’ financial performance for the benefit of bond investors. Municipal bond underwriters can waive these disclosure requirements under certain circumstances, including if they sell the bonds to sophisticated investors who plan to hold the securities in a single account and not distribute them. This is often referred to as a limited offering exemption.

In this case, the SEC alleged that Oppenheimer used the limited offering exemption in at least 354 municipal offerings between 2017 and 2022, despite knowing that the offerings did not qualify for the exemption, all in violation of Rule 15c2-12 of the Exchange Act. The SEC alleged that Oppenheimer knew or should have known that it sold the bonds to investment advisers or broker-dealers that intended to split up the securities among different customer accounts, rendering the limited offering exemption inapplicable.

The SEC also asserted that Oppenheimer violated Municipal Securities Rulemaking Board (“MSRB”) Rule G27(c), which requires broker-dealers to adopt, maintain, and enforce written supervisory procedures reasonably designed to ensure that the municipal securities activities of the broker-dealer and its associated persons are in compliance with the Exchange Act and MSRB rules. Oppenheimer allegedly lacked written policies or procedures reasonably designed to ensure such compliance. Finally, Oppenheimer allegedly negligently made deceptive statements to municipal issuers by stating that it would comply with the limited offering exemption, in violation of MSRB Rule G-17. The SEC seeks disgorgement of $1.9 million in profits from the bond sales, as well as a civil penalty.

SEC Accepts VMware’s Offer of $8 Million Settlement to Resolve Allegations of Misrepresentation of Revenue Based on Delaying Recognition of Sales

On September 12, the SEC accepted a settlement offer submitted by VMware, a cloud computing firm, and imposed a cease-and-desist order prohibiting VMware from committing violations of Section 17(a)(2) and (a)(3) of the Securities Act and Section 13(a) of the Exchange Act and Rules 13a-1, 13a-11, 13a-13, and 12b-20 thereunder. VMware also agreed to pay an $8,000,000 civil money penalty to the SEC.

In support of its order, the SEC found that in fiscal years 2019 and 2020, VMware controlled the timing of tens of millions of dollars of revenue recognition through purposefully delaying the email delivery of additional license keys once it had met its quarterly goals. This practice allowed it to begin the next quarter with a revenue buffer and prevented generating excess revenue in any particular quarter. The delayed license keys would be released automatically as soon as a quarter ended, and at that point revenue for the sale would be recognized. While VMware disclosed the number of delayed license keys in its quarterly and annual reports, it did not disclose that delays were discretionary and used to manage the timing of its revenue recognition. According to the SEC, when VMware experienced slower business growth in fiscal year 2020, it concealed this slowdown by releasing delayed license keys to cover the losses, thus recognizing additional revenue. This enabled it to report an 11% boost in revenue in the first quarter of 2020. Afterwards, with little backlog remaining, its reported sales dropped. By the end of the fourth quarter of fiscal year 2020, VMware’s stock price had fallen by approximately 37% from its closing price in the first quarter of that year.

The SEC also found that while internally VMware was concerned about the declining backlog, in quarterly earnings calls in the first three quarters of fiscal year 2020, it assured investors and analysts that the company continued to experience strong growth, dismissing questions from analysts as to the gap between its apparent strong revenue growth and that of competitors. In the fourth quarter, while VMware acknowledged a decline in revenue, it attributed that only to general challenges in their product market rather than specifically to its backlog practices. The SEC found that in doing so, VMware omitted material information regarding the extent to which the company controlled the timing of revenue through purposeful delays. The SEC also alleged that VMware’s ability to meet revenue guidance was material to its stock price, and as such those omissions were violations of Sections 17(a)(2) and (3) of the Securities Act, which require only a finding of negligence rather than intent. The SEC also found that VMware violated Section 13(a) of the Exchange Act and Rules 13a-1, 13a-11, 13a-13 and 12b-20 thereunder, which require timely filing of reports containing material information necessary to make required financial statements not misleading.

In a press release, VMware noted that it has not admitted or denied the SEC’s findings, and that the settlement will conclude the SEC’s investigation into the matter at hand. For other companies, it is an important reminder that sales practices and revenue recognition can and do attract regulatory scrutiny even if ever dollar is accounted for in the correct amounts and reporting period in accordance with GAAP.

Twitter v. Musk Update: Musk Is Allowed to Amend Counterclaims Before Trial Based on Whistleblower Complaint

As the October trial date approaches in the Delaware Court of Chancery, Twitter and Elon Musk continue to dispute the scope of the case wherein Twitter seeks to enforce Elon Musk’s $44 billion buyout. On September 7, the Court of Chancery granted Musk’s motion for leave to amend on the basis of new allegations about Twitter’s metrics in a whistleblower complaint filed by former Twitter employee Peiter “Mudge” Zatko, but denied his simultaneous motion to extend the case schedule. Musk alleged that through the course of the legal proceedings, he did not know about the whistleblower complaint or underlying allegations, initially filed with various federal authorities on July 6, 2022, and published by the Washington Post on August 23. The whistleblower alleged that Twitter based its revenue-generating traffic forecasts on faulty assumptions about the number of spam and bots on the site. In advance of the motion, Musk sent Twitter a letter purporting to terminate the merger agreement on new grounds based on the whistleblower allegations, and moved to amend his counterclaims accordingly.

Twitter opposed Musk’s motion for leave to amend, arguing that the amendment would be futile, given that Musk dispatched with any diligence in making the deal, and that amendment would be prejudicial as it would expand discovery and extend the case schedule, leaving Twitter in further uncertainty. The Court of Chancery granted the motion to amend, noting that the liberal, movant-friendly rule on amendment is intended to allow each case to be resolved on the merits, and that a newly-published whistleblower complaint would be grounds in most instances to permit amendment. The Court declined to address the individual counterclaims added in advance of having them fully litigated.

The Court considered Twitter’s arguments as to prejudice, and limited additional discovery only to “incremental discovery relevant to the new allegations,” accordingly. The Court denied Musk’s motion to extend the case schedule, noting that further delay would lead to a greater risk of irreparable harm to Twitter and that Twitter had agreed to respond to reasonable requests for additional discovery while maintaining an October 17 trial start date.

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Lawyers in Goodwin’s Securities and Shareholder Litigation and White Collar Defense practices have extensive experience before U.S. federal and state courts, legislative bodies and regulatory and enforcement agencies. We continually monitor notable developments in these venues to prepare the Securities Snapshot — a bi-weekly compilation of securities litigation news delivered to subscribers via email. This publication summarizes news from the civil and criminal securities law arenas in a succinct, digestible format. Topics covered include litigation and enforcement matters, legislation, rulemaking, and interpretive guidance from regulatory agencies.

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