After almost two years of litigation and negotiation that started on November 14, 2016 with an SEC cease and desist administrative proceeding (pdf) before an SEC Administrative Law Judge (ALJ), Alexander Kon submitted an offer of settlement (pdf) that the SEC accepted on May 29th, 2018. This is a very simple case but it is important in that it addresses the legality of incorrectly listing the name of the party that paid for a stock promotion. Also, it addresses the legality of the SEC hearing cases before its own ALJs. The second issue is beyond my legal interest so I encourage the interested reader to read Brenda Hamilton’s blog post on the case.
The facts of the case as contained in the settlement (pdf) are as follows:
1. In early 2014, as part of an effort to increase his company’s (“Issuer A”) stock price, Issuer A’s former CEO (the “Former CEO”) retained Kon to disseminate information about Issuer A.
2. Kon possessed an email list and various websites through which he touted microcap stocks. Oftentimes, Kon hired other promoters to help distribute touts.
3. After various email exchanges and phone calls between the Former CEO and Kon, they agreed that for $25,000, Kon would run a marketing campaign on Issuer A stock on April 14, 2014 via four websites that Kon operated: 1)
007stockchat.com; 2) awesomestocktips.com; 3) otcfire.com; and 4) pennystockspy.com.
4. Kon and the Former CEO interacted with each other to both organize the promotional campaign and to make arrangements for payment for the campaign. The $25,000 payment to Kon was effected via wire transfer by the Former CEO and was in response to an invoice Kon sent directly to the Former CEO. However, despite Kon interacting exclusively with the Former CEO, sending the invoice directly to the Former CEO, and receiving payment from a transaction effected by the Former
CEO, Kon determined that the disclaimer for each of the touts on the four websites would note that Kon received money from “third party Casey Cummings.” Moreover,
Kon was aware that Casey Cummings was the Former CEO’s son, yet did not disclose this in the touts either.”
Brenda Hamilton identified the company (Issuer A) as CannaBusiness Group (CBGI) and the “Former CEO” (more appropriately referred to as the “then-CEO” in my opinion and referred to in that way by Brenda Hamilton), as Michael Cummings.
On the same day that the initial proceeding against Alexander Kon was announced, the SEC announced a settlement with Casey Cummings (pdf).
The violation listed in the SEC settlement with Kon is:
As a result of the conduct described above, Kon willfully violated Section 17(b) of the Securities Act, which prohibits the publication of any notice, circular, advertisement, newspaper, article, letter, investment service, or communication which, though not purporting to offer a security for sale, describes such security for a consideration to be received from an issuer, without fully disclosing the receipt of such consideration and the amount thereof.
The penalty agreed to by Kon and the SEC was a 12 month suspension “from participating in any offering of a penny stock, including: acting as a promoter, finder, consultant …”. Also, Kohn “shall pay disgorgement of $25,000, prejudgment interest of $332, and a civil money penalty of $20,000, for a total of $45,332”.
Getting back to the topic of the legality of incorrectly identifying the paying party in a stock promotion, see the ruling of the ALJ (pdf) in Kon’s case from early 2017 (shortly before the proceeding was stayed (pdf) because of questions about the legality of the SEC hearing cases in front of their ALJs).
From that ruling (emphasis added by me):
Respondent argues that the misconduct alleged in the OIP did not amount to a violation of the law because the websites at issue disclosed the fact and amount of consideration received. See Motion at 7-10. Respondent contends that Section 17(b) does not require disclosure of the source of the consideration, and that “misidentifying the source of the consideration” does not violate Section 17(b). Motion at 8.
A reading of the statutory text alone is sufficient to reject this contention. Section 17(b) contains two elements directly relevant here: (1) the consideration at issue must be “fully disclos[ed]”; and (2) the duty to disclose only arises when the consideration is from an issuer, dealer, or underwriter. 15 U.S.C. § 77q(b). Full disclosure means exactly that – disclosure that is fulsome rather than incomplete. If consideration is received from an issuer, but the only disclosed consideration is gratuitously (or misleadingly) reported to be from a third party, then the consideration from the issuer is not “fully disclos[ed]” within the meaning of Section 17(b). Such a disclosure constitutes an omission, not merely a misidentification of the source of the consideration. Here, drawing all reasonable inferences in the Division’s favor, Respondent allegedly omitted disclosure of consideration received from the issuer (via its CEO), and thereby failed to fully disclose that consideration under Section 17(b).
In urging a different result, Respondent cites SEC v. Recycle Tech, Inc., No. 12-21656-CV-LENARD, 2013 WL 12063952 (S.D. Fla. Sept. 26, 2013). See Motion at 10. In Recycle Tech, two defendants were charged with violating Section 17(b) based on disclaimers stating that they had “received from a third party non affiliate 2.325 million free trading shares of [Recycle Tech] for advertising and marketing,” or similar language. 2013 WL 12063952, at *8. According to the complaint, however, both defendants had received their shares indirectly from Recycle Tech, the issuer. See id. The district court held that “misidentifying the source of the consideration” did not violate Section 17(b) because the disclaimers “‘fully disclos[ed] the
receipt . . . of such consideration and the amount thereof.’” Id.
According to Respondent, the district court’s holding “clearly demonstrate[s] that the Respondent’s alleged actions are not in violation of Section 17(b).” Motion at 10. I respectfully disagree with the district court’s construction of Section 17(b), because that construction did not consider the entirety of the statutory text. The other cases upon which Respondent relies are either factually distinguishable or do not support his position. See Motion at 8-9; Reply at 13.
I previously blogged about the Recycle Tech suit.
Because the Recycle Tech ruling was from a district court judge while the ruling in this case was from an SEC ALJ, I believe that a future defendant could have a good case for arguing that the district court ruling is the correct precedent. However, by aggressively pursuing this case, the SEC has shown that it still believes that any false information in a stock promotion disclaimer violates Section 17(b). Expect this issue to be litigated more in the future.