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Cady Bar the Door Insight & Commentary on SEC Enforcement Actions and Related Issues

Zoom! SEC Freezes Assets in a Flash

Posted in Microcap Fraud, Non-scienter-based Violations, SEC Litigation

I don’t give investment advice on this blog.  And what I’m about to say is not particularized investment advice that I’m being compensated for, but I feel okay telling you this:  If someone asks you to invest your money in a biomedical technology company that three months ago operated under a different name and was devoted to making leather bags, stop what you’re doing.  Find a trusted confidante, explain what you are considering, and think about whether you like having that money.  Not everyone does that.

Down Goes Biozoom

That was the situation facing the SEC today when it announced charges against eight Argentine citizens who allegedly sold millions of shares of Biozoom, Inc. in unregistered transactions.  Biozoom is the biotech company I refer to above.  It used to be called Entertainment Art, Inc., when it was in the leather bags business.  Whatever its name, trading has been suspended in the company’s securities, and the company is now under siege.  The SEC also obtained an emergency order to freeze assets in the U.S. brokerage accounts of the eight defendants and two other Argentine citizens who had Biozoom shares but had not yet sold them.

The SEC’s complaint alleges that from March to June 2013, the ten defendants received more than 20 million shares of Entertainment Art, one-third of the company’s total outstanding shares. In a one-month period beginning in mid-May, eight of them sold more than 14 million shares. The sales yielded almost $34 million, of which almost $17 million was wired to overseas bank accounts.  The SEC alleges that these sales were not appropriately registered or exempt from registration under Section 5 of the Securities Act.  The defendants’ U.S. brokerage accounts, which include approximately $16 million in cash, are subject to the asset freeze.

My Take

Microcap cases like this one can seem a little dinky, but I think they’re important for the SEC to do for a couple of reasons.  First, it is very unlikely that any other law enforcement agencies will cover them.  From a resources perspective, these schemes are generally beyond the reach of state agencies.  There are exceptions, but typically the SEC is the only game in town.  And $34 million is a lot of money to slip through the cracks entirely.  Second, transactions in penny stocks can be an effective money laundering tool.  There’s been no accusation that this is what Biozoom and the people involved in the transactions were up to, but punishing unregistered sales of securities generally could be an effective way to combat this risk.

Finally, the SEC did a smart thing here in seeking redress only for the unregistered sales under Section 5 of the Securities Act and not for securities fraud under Section 17(a) of the Securities Act or Section 10(b) of the Exchange Act.  Proving the latter claims – especially against foreign defendants – can be very hard to do in these matters.  Given that Section 5 has no scienter element, and can still yield civil penalties, it is a much quicker, cleaner way to go and will preserve staff resources for bigger fish.