Old Blog Learns New Tricks

This is the first installation of a new turn for this blog. I have decided that I shall now do the following: track developments in securities law, explain the law in a general, accessible manner, and provide some context. The first posts might be a little rocky, but like a traditionally fine-tuned pension fund profit curve, we hope to smooth them out – whether warranted or otherwise.

Today’s lucky winner is Freedom Golf. On March 16, 2006, the SEC announced that the United States District Court for the District of Colorado ordered Defendant Carter Allen Jones to pay disgorgement, interest and a civil penalty in relation to a “pump and dump” scheme. The SEC had originally charged Jones and his company with violations of Sections 17(a) and (b) of the Securities Act of 1933 and Section 10(b) of the Securities Exchange Act of 1934 and Rule 10b-5 thereunder.

The charges stemmed from a “pump and dump” scheme involving the common stock of a corporation called Freedom Golf Corporation. A pump and dump scheme is one in which a small group of investors snaps up the stock of a company and then persuades (“pumps”) other investors to purchase that stock. After the share price increases, the original group of investors then sells (“dumps”) the stock. The share price plummets, and the investors still holding shares take a loss, while the original investors walk away with substantial profits. The scheme is quite simple and quite illegal.

With Freedom Golf, the defendants not only recommended the stock, but also gave false information to a broker-dealer to give to the NASD to initiate public trading of the predecessor company of Freedom Golf. They rounded up investors via millions of spam e-mails, and created profit, revenue and expense projections for Freedom Golf that had no foundation in fact. The complaint filed by the SEC alleged that the defendants cleared $500,000 of profit.

The scheme itself is simple enough as is the hook that the SEC used to round up the defendants. The SEC originally pursued the defendants under three separate statutory provisions and one federal regulation: Sections 17(a) and (b) of the Securities Act of 1933 and Section 10(b) of the Securities Exchange Act of 1934 and Rule 10b-5 thereunder.
What did they violate?

The Securities Act of 1933

Section 17(a) states that: It shall be unlawful for any person in the offer or sale of any securities or any security-based swap agreement (as defined in Section 206B of the Gramm-Leach-Bliley Act) by the use of any means or instruments of transportation or communication in interstate commerce or by use of the mails, directly or indirectly – (1) to employ any device, scheme, or artifice to defraud, or (2) to obtain money or property by means of any untrue statement of a material fact or any omission to state a material fact necessary in order to make the statements made, in light of the circumstances under which they were made, not misleading; or (3) to engage in any transaction, practice, or course of business which operates or would operate as a fraud or deceit upon the purchaser.

Section 17(b) states that: It shall be unlawful for any person, by the use of any means or instruments of transportation or communication in interstate commerce or by the use of the mails, to publish, give publicity to, or circulate 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 received or to be received, directly or indirectly, from an issuer, underwriter, or dealer, without fully disclosing the receipt, whether past or prospective, of such consideration and the amount thereof.

The Securities Exchange Act of 1934
Section 10(b) states that: It shall be unlawful for any person, directly or indirectly, by the use of any means or instrumentality of interstate commerce or of the mails, or of any facility of any national security exchange – To use or employ, in connection with the purchase or sale of any security registered on a national securities exchange or any security not so registered, or any security-based swap agreement (as defined in section 206B of the Gramm-Leach-Bliley Act), any manipulative or deceptive device or contrivance in contravention of such rules and regulations as the Commission may prescribe as necessary or appropriate in the public interest or for the protection of investors.

17 CFR 240.10b-5 Employment of Manipulative and Deceptive Devices
It shall be unlawful for any person, directly or indirectly, by the use of any means or instrumentality of interstate commerce, or of the mails, or of any facility of any national securities exchange, (a) to employ any device, scheme or artifice to defraud, (b) to make any untrue statement of a material fact or to omit to state a material fact necessary in order to make the statements made, in the light of the circumstances under which they were made, not misleading, or (c) to engage in any act, practice, or course of business which operates or would operate as a fraud or deceit upon any person, in connection with the purchase or sale of any security.

It is clear that the SEC had various hooks by which they could round up the brains behind the Freedom Golf “pump and dump” scheme. They could prosecute them for each instance of untrue information they fed to investors in order to persuade investors to purchase the stock. Moreover, they could prosecute the defendants for omitting to state that all of the information regarding the financial health of the company was untrue, as well as failing to mention that they planned to dump the stock as soon as everyone bought in. They could prosecute the defendants for failing to disclose that they owned the stock, for fraudulently registering the stock on the NASD, and for planning the scheme in the first place.

The above does not constitute legal advice. It is mere conjecture on the part of the person who maintains the blog.