Although it would be nice if the Securities and Exchange Commission could routinely engage in a qualitative review of all proposed offerings, in reality, the federal regulator lacks the resources in terms of both dollars and staffing. Consequently, proposed securities registrations are generally submitted to a fairly cursory review focusing on generic checklists of basic disclosures items. Should there be a more rigorous review? Should a federal regulator be engaged in a more hands-on verification of qualitative and quantitative factors? The answers to such questions are not easy. There are those who fear that enhancing a regulator's so-called gatekeeper role could retard capital formation and place expensive and time-consuming roadblocks in the path of raising public funds. In contrast, there are those who argue that our markets are filled with listings and products concocted by scamsters and that victimized markets demand more exacting controls over securities registrations. Notwithstanding that robust debate, consider this recent SEC Stop Order and the alleged misrepresentations and omissions that prompted such action. If nothing else, caveat emptor still has validity.
Case In Point
On April 25, 2012 (and as amended seven times thereafter from August 2012 to November 2013), Blue Mountain Eco Tours, Inc. filed a Form S-1 registration statement with the Securities and Exchange Commission ("SEC") seeking to register the offer and sale of 3,041,000 common shares. After reviewing the filings, the SEC's Division of Enforcement (the "Division") alleged that the S-1 contained untrue statements of material facts and omitted material facts necessary to ensure that the filing was not misleading. Accordingly, the SEC instituted proceedings in the public interest pursuant to Section 8(d) of the Securities Act of 1993 determine whether a Stop Order should suspend the effectiveness of the S-1.In the Matter of the Registration Statement of Blue Mountain Eco Tours, Inc. (Order Instituting Proceedings, SEC, '33 Act. Rel. No. 9995; Admin. Proc. File No. 3-17011 / December 21, 2015) (the "OIP").
SIDE BAR: Section 8 of the Securities Act of 1933:
(d) If it appears to the Commission at any time that the registration statement includes any untrue statement of a material fact or omits to state any material fact required to be stated therein or necessary to make the statements therein not misleading, the Commission may, after notice by personal service or the sending of confirmed telegraphic notice, and after opportunity for hearing (at a time fixed by the Commission) within fifteen days after such notice by personal service or the sending of such telegraphic notice, issue a stop order suspending the effectiveness of the registration statement. When such statement has been amended in accordance with such stop order the Commission shall so declare and thereupon the stop order shall cease to be effective.
The Walking Wounded?
Right off the bat, the OIP asserts that Respondent Blue Mountain was anything but a robust, vibrant company:
Moreover, the OIP charges that certain S-1 representations appear to suggest circumstances that aren't as depicted; whereas unstated guidance raises troubling questions about what's truly going on behind the scenes and who may be pulling the strings:
1. Respondent is a revoked Nevada corporation headquartered in Kingston, Jamaica. Respondent is delinquent with its annual filing fee obligations and its submission of its list of officers. It has not paid filing fees nor submitted its list of officers from December 31, 2012 to present.
2. The Registration Statement includes untrue statements of material facts and omits to state material facts necessary to make the statements contained therein not misleading. The untrue statements and omissions of material facts are as follows:
a. The Registration Statement states that Respondent has a sole officer and director and that "[w]e have no significant employees other than our sole officer and directorů" These disclosures are false and misleading because Respondent has undisclosed control persons and/or promoters, who are different than the sole officer and director listed in the Registration Statement. One of the undisclosed control persons and/or promoters:
i. had sole signatory authority over Respondent's bank account;
ii. was listed as Respondent's corporate secretary;
iii. authorized over 30 ATM withdrawals from Respondent's bank account for unknown purposes;
iv. paid fees to professionals that facilitated the filing of Respondent's Registration Statement, including to its auditor and attorney;
v. withdrew thousands of dollars of so-called consulting fees and travel expenses from Respondent's bank account;
vi. established Respondent's website;
vii. communicated with the law firm that facilitated the filing of Respondent's Registration Statement providing it with drafts of its Form S-1 and draft responses to the Commission's Division of Corporation Finance staff's comments to Respondent's Registration Statement; and
viii. has custody of all of Respondent's corporate documents.
b. The Registration Statement states that the Respondent's sole officer and director loaned $15,219 to the company. This disclosure is false and misleading because Respondent's sole officer and director did not loan any money to Respondent.
c. The Registration Statement states that Respondent repaid its sole officer and director $10,000 of the loan. This disclosure is false and misleading because Respondent did not repay any money to its sole officer and director. d. The Registration Statement states that Respondent's sole officer and director "earned the Sustainable Travel Certification." This disclosure is false and misleading because Respondent's sole officer and director did not earn the Sustainable Travel Certification.
e. The Registration Statement states that Respondent was founded in Montego Bay, Jamaica with the company "providing hiking expeditions into the Blue Mountain region." This disclosure is false and misleading because Respondent was not founded in Montego Bay, Jamaica and has no operations.
f. The Registration Statement states that Respondent is a Nevada corporation. This disclosure is false and misleading because Respondent's corporate status is listed as "revoked."
The Sounds of Silence
Although the Division filed an affidavit of service of the OIP upon Respondent Blue Mountain's agent, the Respondent failed to timely answer by January 4, 2016; and, thereafter, failed to answer or defend itself at the proceeding, which occurred in a default manner. In the Matter of the Registration Statement of Blue Mountain Eco Tours, Inc. (Initial Decision of Default, SEC, Initial Dec. Rel. No. 966; Admin. Proc. File No. 3-17011 / February 26, 2016).
The One and Only?
The ALJ's Initial Decision of Default found as false the assertions in the S-1 that identified Donald Lindo as Blue Mountain's sole officer and director, and that the company had no other significant employees other than Lindo. Contrary to said S-1 representations, the Initial Decision found that Douglas Roe, Kelly-Ann Warawa, and Daniel Swanson played significant roles in Blue Mountain's operations:
For example, Warawa had sole signatory authority over Blue Mountain's bank account, and she was designated as "corp. secretary" of Blue Mountain on the associated paperwork. OIP at 2; Ex. D at 76, 78-79; Ex. F at 37-38, 170. Lindo, purportedly the company's only significant employee, had almost no knowledge about Blue Mountain's finances. He had never seen any of the company's bank account statements prior to his investigative testimony, and he did not have access to the checkbook, credit card, or debit card associated with Blue Mountain's account. Ex. F at 169-70. He was unaware that thousands of dollars were withdrawn from the account to pay Warawa and Roe "consulting fees," and he did not know whether plane tickets purchased by the company in September 2011 were for legitimate business travel. See OIP at 2; Ex. F at 38-39, 175-76, 207-08; Ex. H. Lindo also professed to be unaware of over thirty ATM withdrawals from Blue Mountain's bank account that took place in August and September 2011. OIP at 2; Ex. E; Ex. F at 168, 173-74. He admitted that Warawa "handled all the financial stuff . . . all the accounts," and testified that because of this, disbursements from Blue Mountain's account were made without his approval. Ex. F at 37-38. Warawa also maintained all of Blue Mountain's corporate records, none of which were in Lindo's possession, custody, or control. OIP at 2; Ex. F at 41-42.
Hiring of Auditor and Lawyer
Contrary to Lindo's purported dominant role as presented in the S-1, it appears that he was unaware of many financial matters and decisions, which were allegedly made by Warawa and/or Roe. Additionally, the Initial Decision alleged that:
Blue Mountain hired an auditing firm, M&K CPAs, PLLC, and a law firm, Dean Law Corp., to assist with the filing of its registration statement. Ex. G; see OIP at 2. Lindo did not know that an auditor had been hired or what role an auditor might play in the preparation of a Form S-1. Ex. F at 150-51. Emails indicate that payments to the auditing firm were handled by Roe. Ex. G at 45, 2900, 3744, 3553. These emails also show the involvement of Swanson in communicating with Faiyaz Dean, an attorney at Dean Law Corp., making deposits with Dean Law Corp. in Blue Mountain's trust account, and "dealing with . . . the DTC eligibility" for Blue Mountain. Id. at 89, 3410. In May 2011, Swanson also registered a website domain name for Blue Mountain. OIP at 2; Ex. I.
Roe spearheaded the substantive discussions with the auditor and Dean regarding preparation of the registration statement and responses to comments on the Form S-1 received from staff in the Commission's Division of Corporation Finance. See OIP at 2; Ex. J. Warawa was also involved in these discussions, and she sent Blue Mountain's draft comment letter response to Dean. Ex. J at 3258, 4241. No evidence suggests that Lindo actively participated in the filing or comment letter process; he testified that he did not know what a Form S-1 was used for or with whom it was filed, and he did not know what a response to a comment letter was. Ex. F at 101-04, 166.
The Initial Decision found that the S-1 had misrepresented more than Lindo's role at Respondent Blue Mountain. Additionally, there were allegations that much of the Respondent's history and the descriptions of its business were fanciful, fabricated, and untrue:
In addition to misrepresentations and omissions regarding key individuals at Blue Mountain, the registration statement also contained untrue statements about the company's history, operations, and corporate status. See OIP at 2-3. For example, the registration statement states that Blue Mountain was founded in Montego Bay, Jamaica, and was "providing hiking expeditions into the Blue Mountain region." Id. at 3; Ex. C at 23. In reality, Blue Mountain was based in Kingston, Jamaica, and it "wasn't an operating company" and "did not provide any hikes or anything of that sort." Ex. F at 41, 228-29. The registration statement also falsely represents that Blue Mountain's sole officer and director (Lindo) had "earned the Sustainable Travel International Certification." OIP at 2-3; Ex. C at 22. Lindo had never heard of such a certification and had not earned it. Ex. F at 227. And though the registration statement correctly notes Blue Mountain's state of incorporation as Nevada, none of the amendments disclose that the company's status is "revoked," its business license having expired on December 31, 2012. Ex. B; Ex. C (passim).
A Lack of Support
Finally, the Initial Decision considered representations in the S-1 to a purported $15,000 loan by Lindo to Respondent Blue Mountain:
Several amendments to the Form S-1 state, and Lindo insisted during his testimony, that Lindo loaned approximately $15,000 to Blue Mountain. Ex. C at 3311 ; Ex. F at 63-64. But when sending his comments on the draft Form S-1 to Dean, Roe noted with respect to the funds allegedly advanced by Lindo: "The funds that came in from Dan the 10k that was for blackbear we will apply that as blue mountains money perhaps part as seed and part as loan?" Ex. K at 3094. A ledger maintained by Dean Law Corp. supports the assertion that Swanson contributed money to the company, reflecting $11,000 in cash deposits made by Swanson to Blue Mountain's trust account. Id. at 6762. But it provides no corroboration for the contention that Lindo contributed any money, and none of the other exhibits support this claim. Id.; see OIP at 2. Amendments to the Form S-1 also state that $10,000 of the purported loan was repaid to Lindo, but Lindo testified that he was not repaid any money. OIP at 2; Ex. C at 1232; Ex. F at 64.
Conclusions of Law
In deciding whether to grant registration, the analytical point of departure in the Initial Decision is the federal regulator's mandate to protect investors by ensuring full disclosure of all information that a reasonable investor would deem important in determining whether to undertake a proposed purchase. The Initial Decision found that Respondent Blue Mountain failed to comply with its disclosure obligations in filing its S-1. In ordering the S-1's effectiveness suspended, the Initial Decision offers this rationale::
[F]irst, it overstates Lindo's role in the company, which was minimal rather than significant. It also fails to disclose the involvement of Warawa, Roe, and Swanson, each of whom participated substantially in the operation of the company. A control person is one who, directly or indirectly, has "the power to direct or cause the direction of the management and policies of a person." 17 C.F.R. § 230.405. By omitting mention of Warawa, Roe, and Swanson, Blue Mountain failed to provide a complete answer to Item 11(n) of its Form S-1, which requires a registrant to furnish the information required by Item 404 of Regulation S-K, including the identity of any control person of the registrant within the last five fiscal years. See Item 11(n) of Form S-1; 17 C.F.R. § 229.404. Both courts and the Commission have held that failure to disclose control persons' participation in an issuer's formation, offering, and operations constitutes a material omission. See SEC v. Fehn, 97 F.3d 1276, 1290 (9th Cir 1996); The Registration Statement of Hughes Capital Corp., Securities Act Release No. 6725, 1987 SEC LEXIS 4158, at *18-19 (July 20, 1987); Am. Fin. Co., Securities Act Release No. 4465, 1962 SEC LEXIS 632, at *5 (Mar. 19, 1962); Hart Oil Corp., Securities Act Release No. 4147, 1959 SEC LEXIS 33, at *4-5 (Oct. 9, 1959). Finally, the registration statement contains materially false and misleading information about Blue Mountain's founding and operations in Jamaica, corporate status, and borrowing history. Issuance of a stop order is plainly appropriate in light of these numerous misrepresentations and omissions.