by Bill Singer
Back to the Future? SEC Launches Pennystock Case
January 6, 2011
A Securities and Exchange Commission ("SEC") Complaint filed on January 6, 2011, in federal district court in Sacramento, California charges Gendarme Capital Corporation ("Gendarme"), its Chief Executive Officer Ezat Rahimi, and its Vice President Ian Lamphere with engaging in an illegal stock distribution scheme in which Gendarme purportedly sold in excess of 15 billion shares of at least twelve companies for a net profit of no less than $1.6 million. Securities And Exchange Commission, Plaintiff, Vs. Gendarme Capital Corporation, Ian Lamphere, Ezat Rahimi, And Cassandra Armento, Defendants. (E.D.Ca/Sacramento, 11-Cv-00053fcd -Kjn)
Basic Facts
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The Over-The-Counter ("OTC") marketplace is organized into three tiers based on the level of disclosure companies choose to provide to investors: OTCQX, OTCQB and Pink Sheets. The Pink Sheets' website states that "Pink Sheets is the third tier of the OTC market. Pink Sheets is the speculative trading marketplace that has no financial standards or reporting requirements. Pink Sheets companies choose the level of information they provide to investors and may have current, limited or no public disclosure."
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Section 5 of the Securities Act of 1933 requires that securities sales must be subject to registration with the SEC, or must qualify for a statutory exemption. If no statutory exemption applies and the sales are transacted without registration, such sales are in violation of Section 5. Registration requires that investors are provided with financial and business disclosures about the issuer.
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Rule 504 of Regulation D of the Securities Act exempts from registration certain limited offerings and sales of securities that do not exceed $1,000,000. Nonetheless, a purchaser who engages in a distribution of such exempted securities is deemed to be an "underwriter" and any short-term public resales in the short term (within one year for shares of non-reporting issuers) by that purchaser are not exempt from registration.
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Generally, stock issued in a registered public offering is "unrestricted;" whereas, stock issued in an exempt offering requires a stamped legend on the stock certificates warning of any restrictions. Restricted shares are not freely tradeable and remain subject to the conditions of their restrictions. Transfer Agents typically require a lawyer's written opinion before issuing unlegended share certificates for unregistered stock.
A Baker's Dozen Discount?
The Complaint alleges that from early 2008 to at least May 2010, Gendarme bought stock from many Pink Sheets companies at a 30-50% discount to the market price. The issuers set forth in the Complaint are:
- Heathrow Natural Food & Beverage, Inc. ("HRNF"), formerly known as WEHI
- Macada, Inc. ("MCDA"), formerly known as Tri-Star Holdings, Inc. ("TSHL"), formerly known as Rapid Fitness, Inc. ("RPDI")
- Magellan, Inc. ("MGLG")
- Perihelion Global, Inc. ("PHGI"):
- Bederra Corp. ("BEDA"):
- Z Com Networks, Inc. ("ZCMN")
- RCC Holdings, Inc. ("RCCH"):
- 141 Capital, Inc. ("ONCP"):
- RBID.com, Inc. ("RBID
- Brownstone Resources, Inc. ("BWNR")
- Russell Industries, Inc. ("RUSL")
- TidalWave Holdings, Inc. ("TWVH")
The Old In-And-Out
Some agreements entered into by Gendarme with the subject companies resulted in Gendarme obtaining warrants for up to one year in which Gendarme could elect to purchase the company's stock; other agreements provided for outright purchases of issuer stock. The Complaint charges that Gendarme falsely represented to the issuers that the discounted purchases were undertaken for "investment purposes only." However, Gendarme is charged with intending to sell the purchased shares within a year. Moreover, the Complaint alleges that Gendarme flipped most of the shares within days or weeks following purchase.As a consequence, the SEC concluded that Gendarme acted as an underwriter and not an investor. This nuance is a significant difference because an underwriter would not be entitled to a valid exemption from registration for the transactions.
Legal Opinion
In addition to allegations against Gendarme and its two named executives, the Complaint charges that Cassandra Armento, the company's outside counsel, violated federal securities laws by issuing more than 50 purportedly false legal opinions in support of Gendarme's activities. The Complaint alleges that Armento repeatedly informed stock transfer agents that Gendarme was not an "underwriter" and, thus, had no intent to sell the stock - a set of circumstances that would permit Gendarme to obtain so-called freely tradeable, non-restrictive shares. The Complaint alleges that Armento made no inquiry into whether Gendarme intended to resell the stock, and, worse, was likely aware that Gendarme was dumping the stock into the market.
The Downside
The Complaint charges Gendarme, Rahimi, Lamphere and Armento with violating the registration provisions of the federal securities laws.
As to Defendants Gendarme, Rahimi, and Lamphere, the SEC seeks injunctive relief, disgorgement of ill-gotten gains, monetary penalties, and an order barring them from participating in an offering of penny stock.
As to Defendant Armento, the SEC seeks injunctive relief and monetary penalties against Armento.