JOBS Act Leads to First Fraud Case

In March of this year we blogged about the, then proposed, JOBS Act and how this act would eliminate important disclosures meant to protect investors from fraud. The Act lowers the regulatory hurdles for companies who are defined as emerging growth companies. The NY Times reported this week that a company named Caribbean Pacific Marketing is the first company that got its start under the JOBS Act and is being prosecuted for fraud. Here are a few bytes from the NY Times:

...Caribbean Pacific Marketing — a company without revenue since it was created earlier this year — appears to have become the first “emerging growth company” as defined by the JOBS Act to have prompted charges of securities fraud by the Justice Department and an effort by the Securities and Exchange Commission to halt sales of the stock. The government claims a disbarred lawyer from Boca Raton, Fla., is really behind the company. 

Those charges came two months after the S.E.C. allowed the company to begin selling shares under a prospectus that the government now says it knew to be inaccurate. 

The Jumpstart Our Business Start-ups Act defined nearly every business in the United States as an “emerging growth company.” No growth was needed to qualify as such a company, only that it must have less than $1 billion in assets, less than $700 million in shares in public hands and less than five years as a public company. Such companies could sell stock to the public with fewer restrictions, and then report less information to their shareholders than was required from normal companies....

Last week the Justice Department charged that the disbarred lawyer, William J. Reilly, had been trying to sell shares before the offering became effective. Unfortunately for him, he did sell some shares — at 5 cents each — to a buyer who turned out to be working with the F.B.I. In the complaint filed in Federal District Court in Miami, an F.B.I. agent stated the bureau has been conducting, with the S.E.C., “an ongoing undercover investigation targeting penny stock fraud in Florida. 

The complaint stated that Mr. Reilly claimed to own 9.2 percent of the company’s shares, although the prospectus, in its list of people who owned at least 5 percent, did not mention him. The S.E.C. action, announced this week, claimed that Mr. Reilly secretly controlled the company and asked that an administrative law judge halt the public offering. 

Mr. Reilly previously settled — without, of course, admitting or denying he actually violated any laws — an S.E.C. suit claiming he had done something similar at other penny stock companies, allowing insiders to sell restricted shares when they should not have been permitted to do so. He was ordered to comply with the law in the future and barred from practicing as a lawyer before the S.E.C. Last year, the S.E.C. filed another suit, claiming he was continuing to act as a securities lawyer for another penny stock company based in Boca Raton. In March of this year, a federal judge ordered him to comply with the original injunction. In May, he was disbarred for “misappropriating” money held for a different corporate client. 

The Justice Department action states that on July 31, “agents with the F.B.I. and another federal law enforcement agency” met with Mr. Reilly at a Denny’s restaurant in Boca Raton and told him about the investigation. In that interview, it says, Mr. Reilly admitted violating securities laws in selling the Caribbean Pacific stock. The affidavit from the F.B.I. agent also says Caribbean Pacific’s ostensible president, Thomas Hagan, admitted that he knew virtually nothing about the company and that he deferred to Mr. Reilly in decisions regarding it, although it does not say when that admission was made.

In late August, Randall Lanham, a California lawyer representing Caribbean Pacific, sent two letters to the S.E.C., asking that it allow the company to begin selling shares on Aug. 29. In the second of those letters, Mr. Lanham said the company understood that allowing the sale would “not foreclose the commission from taking any action with respect to the filing.” The commission granted the request, and the company was allowed to begin marketing shares under a prospectus that the government knew was inaccurate.

It took another two months for the government to file the actions.

Asked why the S.E.C.’s division of corporation finance allowed the offering to proceed, John Nester, an S.E.C. spokesman, said, “As is always the case, Enforcement and Corporation Finance staff closely and appropriately coordinated their efforts in this case. As soon as staff had the necessary and required evidence to support the pending action in this case, we filed the case.”

The JOBS Act appears to be a good example of legislation that is going to end up leading to a significant uptick in fraud cases that are then turned over to the Justice Department who has more than it can handle already. It appears that the Justice Department has more than it can handle trying to figure out if it will hold someone (anyone) accountable for the mortgage meltdown. This pattern of the Justice Department having more than it can handle appears to be fitting though given that Bernie Madoff was allowed to grow his Ponzi scheme to over $50 billion despite numerous warnings given to the SEC...