Wall Street Eugenics : SEC Charges Microcap Fraud . . . again
Written: January 27, 2012
After some three decades lawyering on Wall Street, I ask your pardon if, at times, I come off as overly cynical, hardboiled, and curmudgeonly. I mean, you know, seriously, if you’ve seen even a tenth of the garbage and nonsense that I have during my career, you would likely have the same grumpy demeanor.
Too much of what presently passes for securities regulation strikes me as thwarting natural selection. Permit me the observation that some folks are just too stupid to be allowed to invest in the stock market, and it may be best for the rest of us to let them get fleeced and bankrupted — you know, take their dollars out of our genetic pool.
Harsh? Sure. Honest? Absolutely. As if decades of earnest securities regulation has enhanced the integrity of the stock markets and prevented generation after generation of Ponzis and Madoffs.
Fraudsters prey upon the gullible and feast upon the foolhardy. Eliminate the protections for those investors who refuse to do their own due diligence, for those who override our human instinct to disbelieve what’s too good to be true, and maybe the con artists will find it all that more difficult to scam the remaining population. The eugenics of Wall Street. Alas, the worst sin is to lie to one’s self — so, yeah, I understand that there’s no way such benign neglect will become the regulatory policy for the securities markets. Still — a guy can dream, no?
An Investment For Morons
Take microcap stocks. Please, take them – take them out to the middle of the ocean and dump them. All of them. As if what??? Serious investors are diving into most of this pennystock crap and making a profit? Fact is, about the only folks making money on this low-priced garbage are the paid touts and the brokerage firms dumping their inventory. No one has had to re-invent the wheel or alter the now time-tested scripts.
Someone you never met cold calls you with a wild and fancy tale about a cancer cure or the next Apple. It’s all too-good-to-be-true but, yet, you run for your checkbook and can’t wait to get into this opportunity.
Sometimes you send your dollars to the broker that you never met from the brokerage firm you never heard of for investment in a stock you didn’t research. Other times, you think you’re smarter than everyone else. You sort of cheat — instead of giving the order to the fast-talking salesman that first called you, you go on to your discount account at Schwab, TD Ameritrade, E*Trade. Then, months later, when the tout no longer answers his telephone or your broker’s firm has shuttered, then you cry and go running to a lawyer or a regulator. Gimme a break!
SEC v. First Resource Group LLC and David H. Stern (Complaint, SDFL, 12-cv-60137-XXXX, January 26, 2012) asserts four counts alleging violations of Section 17(a) of the Securities Act of 1933, and Sections 10(b) and 15(a) of the Securities Exchange Act of 1934 and Rule 10b-5. The Complaint alleges that from December 2008 through at least May 2010, defendants First Resource Group LLC and its principal David H. Stern engaged in a scheme in which they:
fraudulently touted the stock of TrinityCare Senior Living, Inc. and Cytta Corporation (two thinly-traded microcap companies);
sold each company’s stock at the same time they were touting it; and
manipulated the market for each stock.
NOTE: The charges contained in the Complaint are merely allegations, and the defendants are presumed innocent unless and until proven guilty in a court of law.
Cast of Characters
First Resource Group of Fort Lauderdale, FL, is a Florida limited liability company organized in September 2008 by Stern. First Resource has never been registered with the SEC and has not registered any offering of securities under the Securities Act. The SEC alleges that the firm’s sole business was promoting penny stocks.
Stern, 48, Tamarac, FL, was First Resource’s sole manager and not associated with a registered broker, or dealer during the relevant period.
We are the first Medical Health Services Provider to coordinate and verify data transmission and medical device connectivity. Our system supports Payors & Providers efforts to provide better and faster care to their patient members.
TrinityCare is a rapidly emerging growth company formed to meet the needs of senior adults, through the development and management of senior living community. These facilities will typically be in association with a local, host church, which has contributed land in exchange for ownership in the facility. In addition to the local host church, TrinityCare develops positive ministry relationships with all segments of the community, including as a significant relationship with the broad Christian community.
Also, watch this 2010 Fox Business News interview with the company’s CEO Donald M. Saupaugh:
The Complaint alleges that defendant First Resource signed agreements to promote TrinityCare and Cytta’s stock, for which the firm received 150,000 shares of TrinityCare stock and 200,000 shares of Cytta stock. From December 2008 through at least May 2010, Stern and First Resource allegedly paid telemarketers to cold-call investors and solicit them to purchase shares in the two penny stocks. These telemarketers were allegedly hired and trained by Stern, and the operation was purportedly conducted out of First Resource’s sole office (in Fort Lauderdale).
Armed with information provided to them by Stern, the telemarketers allegedly prepared sales scripts to pitch the stock to potential investors. According to the Complaint, Stern reviewed the draft versions of the scripts, made edits, and approved the final drafts before the telemarketers were allowed to use them, which were supposed to be used verbatim.
Stern gave the telemarketers a computer database list of registered representatives at broker-dealers, who were targeted for the cold calling and stock pitches. Once an investor agreed to purchase one of the stocks, the telemarketer who solicited that investor gave Stern the investor’s name, the brokerage firm where the investor’s account was held, and the number of shares to be purchased. Telemarketers earned a modest salary and 6% sales commission on all verified purchases.
From June 2009 through at least May 2010, First Resource’s telemarketers allegedly made material misrepresentations about TrinityCare’s rapid revenue growth and a projected increase in the company’s stock price; for example, that the company’s stock “is going to be $5-7 in 6-12 months” and the company “is going to be a half-a-billion dollar company in five years or roughly a $40 stock.”
Also, the Complaint alleges that Stern disseminated a research report on TrinityCare stating that, for the year ending December 31, 2009, TrinityCare would show a profit on revenues exceeding $7.2 million. First Resource’s telemarketers and the research report also claimed TrinityCare expected to add at least four newly constructed senior living facilities. It was further alleged that misrepresentations were made that TrinityCare had secured $50 million in financing commitments to construct these new facilities and that the financing was “90% backed by HUD,” (The U.S. Department of Housing and Urban Development).
In fact, the Complaint alleges that the defendants knew or should have known (or were severely reckless in not knowing}that there was no reasonable basis for their claims. Among the facts cited by the SEC on this point were that TrinityCare had:
lost money for the previous two years;
had no realistic prospects of revenues;
had not obtained financing for the new senior living facilities, which were the source of the company’s projected revenue growth; and
was only at the “pre-application” stage to obtain HUD financing for the new facilities.
In light of the above factors, TrinityCare’s stock traded at between $0.41 and $1.95; however, the defendants allegedly projected that the share price would rise to between $5 and $7 a share in the following year. The Complaintalleged that there was no reasonable basis for such a projection.
The Complaint alleges a similar pattern of misconduct concerning Cytta. From December 2008 through April 2009. Stern allegedly disseminated to investors a research report on Cytta touting Cytta’s “[s]ales projections for 2010-2014 should exceed $500 million with a pre-tax net of over $400 million.” The SEC argues against such projections by asserting that according to Cytta’s Form 10-Q filed on February 23, 2009, the company’s auditors’ expressed doubts the company could continue as a going concern. Moreover, the Complaint asserts that Cytta:
had had no profits since its inception in 1997;
had revenues for the year ending December 31, 2008, of only $35,000; and
had net losses for the year ending December 31, 2008 of $70,000.
The Complaint alleged that concurrent with the telemarketers’ recommendations, the defendants were actually selling their shares that they had received from the stock promoters, but did so without disclosing that circumstance. This “scalping” resulted in alleged profits to the defendants.
SIDE BAR: The SEC deems it a fraudulent practice to purchase a security in anticipation of recommending a long-term investment in that same security, but then embarking upon profitable sales following the issuance of the buy recommendation. The regulatory rationale is that it is deceitful to recommend the purchase of a particular security when you have prior knowledge of the issuance of a research report that will be touting a security andyou intend to utilize the buyers’ orders to facilitate your ability to dump your own holdings. This “scalping” of the recommendation is as classic a conflict of interest as can be imagined.
In June 2009, First Resource allegedly received 150,000 TrinityCare shares from a promoter, and during the telemarketing push from June 2009 to May 2010, the defendants purportedly sold approximately 92,000 of those shares, in approximately 84 different transactions, for proceeds of approximately $100,000. Similarly, First Resource received from a promoter, 200,000 Cytta shares in December 2008, and from that date through April 2009, sold 32,150 of those shares, in approximately 11 different transactions, for proceeds of approximately $69,000.
The Complaint charges that the defendants and the telemarketers did not disclose that First Resource was selling TrinityCare or Cytta shares while recommending the purchase of those stocks to investors. Similarly, it was alleged that the research reports disseminated by the defendants TrinityCare and Cytta did not disclose that the defendants were selling their shares.
From December 2008 through at least May 2010, the defendants are charged with manipulating the markets for TrinityCare and Cytta stock in order to create the false appearance of a liquid and active market, and with the goal of inducing investors to buy the stocks. The Complaint alleges that the defendants were not passive in their efforts to realize profits on their promotional shares; to the contrary, it is alleged that Stern systematically submitted bids for small amounts of TrinityCare or Cytta stock at prices higher than the stock’s then-existing price. On numerous occasions, Stern allegedly placed the daily high bid for the stock.
During the summer of 2009, this trading allegedly increased TrinityCare’s stock price from $1.55 a share on June 17, 2009, to $1.95 on July 10, 2009. After the manipulation ended, TrinityCare’s price plummeted to $0.41. Similarly, Stern made numerous purchases of small quantities of Cytta. During Stern’s alleged manipulation from December 2008 to April 2009, Cytta traded as high as $3.25 per share in January 2009 but crashed in April 2009 to $0.04.
From December 2008 through at least May 2010, the Complaint alleges that the defendants profited by more than $169,000 from sales of Trinity Care and Cytta made while the defendants fraudulently touted these companies, scalped investors, and manipulated the markets in the two stocks. The SEC’s complaint alleges that First Resource Group and Stern violated Section 17(a) of the Securities Act of 1933, and Sections 10(b) and 15(a) of the Securities Exchange Act of 1934 and Rule 10b-5. The SEC is seeking permanent injunctions, disgorgement plus prejudgment interest, and financial penalties as well as a penny stock bar against Stern.
For the purpose of proposing a settlement of rule violations alleged by the Financial Industry Regulatory Authority (“FINRA”), without admitting or denying the findings, prior to a regulatory hearing, and without an adjudication of any issue, Mark E. Rauguth submitted a Letter of Acceptance, Waiver and Consent (“AWC”), which FINRA accepted. In... Read On