In the Wake of Facebook’s IPO, Several Firms are Accused of Securities Fraud

 The SEC and FINRA have responded to the increased popularity in owning private shares of major technology companies such as Facebook and Twitter by stepping up enforcement of the pre-IPO market. 

The SEC recently charged Frank Mazzola and his two private investment funds (Felix Investments, LLC and Facie Libre Management Associates, LLC) with securities fraud.   The funds were established solely to acquire shares in Facebook and other tech firms with securities fraud.  The SEC has alleged that these firms misled investors and pocketed undisclosed fees and secret commissions. 

While fund managers are required to fully disclose material conflicts of interest and their compensation, Mazzola and his firms allegedly failed to do so.  Mazzola, Felix, and Facie Libre also earned commissions above and beyond the 5% commission that was disclosed in offering materials during the acquisition of Facebook stock.  To make matters worse, Mazzola and his firms allegedly mislead investors into believing Felix and Facie Libre had ownership in stock of certain tech companies such as Facebook and Zynga, and made false statements which inflated the revenue of Twitter to attract investors.  According to the SEC and FINRA, Mazzola improperly raised over $70 million from investors using such deceitful tactics. 

The SEC complaint against Mazzola, Felix, and Facie Libre request that they be permanently enjoined from violating the various securities laws and to disgorge any and all wrongfully obtained benefits. 

It is important for investors to use caution and diligence when investing in pre-IPO stocks because they typically lack the type of public disclosures that are required for public stock.  If you have been a victim of broker fraud or negligence the attorneys at Cosgrove Law, LLC may be able to help you recover your losses.    

Manifest Disregard of the Facts: A Valid Basis to Vacate an Arbitration Award?

Motions to vacate arbitration awards are becoming more and more common. For example, as noted in the Wall Street Journal, state and federal courts issued 141 written decisions on motions to vacate arbitration awards in 2005. In 2010, the number was 208, a 48% increase from 2005.

Section 10 of the Federal Arbitration Act ("FAA") sets forth the statutory grounds to vacate an arbitration award; namely: (1) where the award was procured by corruption, fraud, or undue means; (2) where an arbitrator evidenced partiality or corruption; (3) where the arbitrators were guilty of misconduct; and (4) where the arbitrators exceeded their power. 9 U.S.C. § 10(a)(1)-(4). In Hall Street Assoc. v. Mattel, Inc., 552 U.S. 576 (2008), the Supreme Court stated that “[w]e now hold that §§ 10 and 11 respectively provide the FAA’s exclusive grounds for expedited vacatur and modification.”

"Manifest distregard of the law" is a judicially created exception to the exclusivity of the grounds for vacatur set forth in the FAA. An arbitration panel acts with manifest disregard if (1) the applicable legal principle is clearly defined and not subject to reasonable debate; and (2) the arbitrators consciously refused to heed that legal principle. However, there is currently a circuit split as to whether Hall Street abrogated this judicially created doctrine.

A party disappointed with the decision of the arbitrator(s) will likely argue that the arbitrators acted with "manifest disregard of the law," and may also try to argue that the decision is in "manifest distregard of the facts." However, the "manifest disregard of the facts" argument is almost certainly destined to fail.

“Insufficient evidence or even wholesale disregard of evidence by an arbitrator is not a sufficient basis for a court to vacate an award.” Williams v. Mexican Restaurant, Inc., No. 1:05-CV-841, 2009 WL 531859, *5 (E.D. Tex. February 27, 2009) (citing Stolt-Nielsen SA v. AnimalFeeds Intern. Corp., 548 F.3d 85, 91 (2d Cir.2008) (stating that “manifest disregard of the evidence” is not a proper ground for vacating an arbitrator’s award); see also Fairchild Corp. v. Alcoa, Inc., 510 F.Supp.2d 280, 286 (S.D.N.Y. 2007) (finding that “[m]anifest disregard of evidence is also not a proper ground justifying vacating an arbitrator’s award.”); Smith v. Rush Retail Centers, Inc., 291 F.Supp.2d 479 (W.D.Tex. 2003) (“[T]o the extent plaintiff is merely alleging that the arbitrators engaged in manifest disregard of the facts, the allegation is not a basis for vacating the award[.]”); ABS Brokerage Services, LLC v. Penson Financial Services, Inc., Civ. No. 09–4590 (DRD), 2010 WL 2723173 at *7 (D.N.J. July 8, 2010) (stating that plaintiffs’ arguments that the arbitrators exceeded their power by acting in “manifest disregard” of the facts were, in essence, an invitation for court to review the arbitrators’ factual determinations, which the court is prohibited from doing); Buechner v. Mid-America Energy, Inc., No. 1:07-CV-109, 2007 WL 2174723, at *4 (W.D.Ky. Aug. 2, 2007) (“To the extent that Respondents seek for this Court to review the arbitrator’s determination of the facts based on proof presented by the Petitioners, the Court cannot; such considerations exceed the scope of the Court’s review.”).

For example, in Mays v. Lanier Worldwide, Inc., 115 F.Supp.2d 1330, 1346 (M.D.Ala. 2000), the plaintiff asserted that, because the arbitrator “totally ignore[d] much favorable evidence,” the award must be vacated under 9 U.S.C. § 10(a)(4). In other words, plaintiff asserted that the arbitrator exceeded his powers or so imperfectly executed his powers because the arbitrator disregarded plaintiff’s evidence. The court stated that it could locate no case authority establishing that an arbitrator’s disregard of alleged “much favorable evidence” was a ground for vacatur under 9 U.S.C. § 10(a)(4). Id. The court found that, rather than asserting a proper basis for vacating the arbitration award, plaintiff's arguments were “nothing more than thinly veiled attempts to obtain appellate review of the arbitrator’s decision, which is not permitted under the FAA.” Id. at 1347 (citing Gingiss Intern., Inc. v. Bormet, 58 F.3d 328, 333 (7th Cir. 1995)).

In sum, while an argument that the arbitrator(s) acted in "manifest disregard of the law" may have traction in some judicial circuits, the "manifest disregard of the facts" argument will likely fail to gain recognition in any judicial circuit.

North Carolina Plaintiffs and Connecticut Defendants End Up in Southern District of New York Due to Presence of New York Attorney Co-Defendant

The law firm of Cosgrove Law, LLC has already counseled one client regarding the investment adviser activities of James Tagliaferri and his TAG Virgin Islands, Inc. (“TAG”). Another TAG client, Matthew Szulik, brought a federal suit in the Eastern District of North Carolina in 2010 on behalf of a number of family trusts. The suit alleged that, among other things, TAG and Tagliaferri, as well as a TAG managing director by the name of Patricia Cornell, committed violations of the U.S. Investment Advisers Act, the North Carolina Investment Advisers Act, the 1934 Act and breach of fiduciary duty. The Complaint also included three claims against a New York attorney that advised TAG and drafted investment documents, including a civil conspiracy claim. In a nutshell, the Complaint alleged that TAG made self-serving and inappropriate investments with the Szulik's trust funds, including investments in Protein Polymer Technologies shares and a race horse through International Equine Acquisition Holdings. According to the Eastern District's opinion, 2012 WL 8 44662 (E.D. NC, March 12, 2012), the Plaintiffs also alleged that they had evidence that TAG received illegal undisclosed kickbacks for the equine investments.

The contractual advisory relationship between TAG and the Plaintiffs was based upon an Investment Management Agreement with a Connecticut choice-of-law provision executed in Connecticut and North Carolina. TAG's office was in Connecticut before it relocated to St. Thomas. None of the transactions or representations at issue took place in New York. The New York attorney and the TAG Defendants moved to dismiss the Complaint on jurisdictional, venue, and 12(b)(6) grounds.

In an opinion that I found to be an excellent, if not belated, law school refresher, Eastern District Chief Judge Dever carefully walked through a succinct analysis of the rules and principles of federal court jurisdiction and venue. In doing so, he concluded that, while the Eastern District federal court possessed personal jurisdiction over the TAG Defendants and venue in the Eastern District was proper for them as well, it lacked both general and specific personal jurisdiction over the New York attorney. But according to Judge Dever, the federal court in Manhattan possessed such jurisdiction. And venue there was proper as to all of the Defendants pursuant to the less utilized 28 USC 1391(b)(3). As such, he ordered the transfer of the entire case pursuant to 28 USC Section 1404.

So the next time your investment adviser spends your money on a race horse or uses it for loans secured by property in Mexico City—you might ask him where his attorney's office is located. Food for thought.

Diamond Foods Announces Audit Committee Findings in Response to SEC and Federal Investigations

Diamond Foods is facing a formal investigation by the SEC and federal prosecutors as to whether certain financial practices involved criminal fraud.  The investigation revolves around how the company made crop payments to walnut growers.  In response, Diamond engaged an audit committee to conduct an internal inquiry into the allegations.    

Diamond made sizable payments to its walnut growers in September that they claimed were an advance on their 2011 crop.  However, three walnut growers allege that they told Diamond that they did not intend to deliver their 2011 crops to Diamond but were assured by company representatives that they could cash the checks anyway.  Some critics believe the payments were used to inflate last year’s earnings by shifting costs into the current year.  Diamond’s fiscal year ends in July so the September payment shifted the costs into the 2012 accounting year.  Diamond contended that these “momentum payments” were made in an effort to optimize cash flow for growers and initially denied that these payments were compensation for last year’s crop.   

Because of the investigation, Diamond has announced that its plans to acquire Pringles from Proctor & Gamble are on hold.  Diamond planed to pay most of the purchase price by issuing its stock to Proctor and Gamble shareholders.  The deal, which was initially valued at $2.35 billion, is now valued at $2 billion based on Diamond’s current stock price.  The company’s stock price was trading around $96 in September are now trading around $33. 

Thus far, Diamond has cooperated fully with the investigation.  The investigation has also opened Diamond up to several securities class-action lawsuits.     

More recently, the audit committee for the company conducted the internal probe on the accounting treatment of the walnut payments.  It concluded that approximately $20 million “continuity” payments made to growers in August, 2010 and approximately $60 million “momentum” payments made in September 2011 were not properly accounted for in the correct periods.  Furthermore, the audit committee identified material weaknesses in Diamond’s internal control over financial reporting. 

In response to these findings, Diamond’s Board of Directions has taken several corrective actions such as appointing a new Chief Executive Officer and Chief Financial Officer.  Diamonds will restate its 2010 and 2011 financial statements. 

Investigators are now likely to review Diamond’s accounts very carefully because accounting violations are rarely an isolated incident.  Diamond is also likely to face a civil enforcement action by the SEC for failure to maintain accurate books and records and failure to maintain adequate internal controls.