Securities Regulation Daily Wrap Up, TOP STORY—D. Conn.: Investment banker must face suit in virtual currency mining fraud, (Oct. 12, 2017)
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Thursday, October 12, 2017

Securities Regulation Daily Wrap Up, TOP STORY—D. Conn.: Investment banker must face suit in virtual currency mining fraud, (Oct. 12, 2017)

By Gregory Kane, J.D., M.B.A.

An investment banker at a prominent firm who provided management, financing, advice, promotion and recruiting services for a virtual currency mining business accused of defrauding its customers was unable to have state and federal control person liability claims and state aiding and abetting claims dismissed in a pending class action suit (Audet v. Fraser, October 11, 2017, Shea, M.).

Background. Stuart Fraser, the vice-chairman of Cantor Fitzgerald investment bank, was friends with Homero Joshua Garza and the two men had founded and run multiple companies together with Fraser providing financing, business advice, direction and mentorship and Garza handling day-to-day operations. The two had a 50-50 ownership split in their companies and Fraser provided money for a salary for Garza and seed capital for the businesses.

In 2014, Garza incorporated GAW Miners to sell virtual currency mining equipment, which was 50% owned by Fraser and financed via $135,000 in seed capital from Fraser and three subsequent $200,000 loans from Fraser. The company offered hardware for mining virtual currency, hardware hosting to allow customers to essentially lease equipment held by GAW, cloud-hosting mining services, shares in virtual currency mining pools which were oversold by at least 100 times GAW’s computing capacity, a proprietary virtual currency, and a proprietary virtual currency time-locked investment vehicle.

Fraser participated in GAW’s operations and strategic decision making, including providing regular direction to Garza. Fraser also contacted potential GAW investors and, due to his access to GAW’s business records, was able to negotiate with third parties on GAW’s behalf. Fraser also allows Garza and GAW access to his credit line at Bank of America and his personal credit card. Fraser also used resources at Cantor Fitzgerald for GAW’s benefit.

Plaintiffs, a putative class of GAW customers, allege myriad fraudulent statements and actions by GAW. The suit alleges GAW violated Section 10(b) and Rule 10b-5 of the Securities Exchange Act; Sections 36b-29(a)(2) and 36b-4 of the Connecticut Uniform Securities Act (CUSA); Section 36b-29(a)(1) of CUSA; and common law fraud. Plaintiffs’ suit alleges Fraser has controlling person liability under Section 20(a) of the Exchange Act; aided and abetted fraud in violation of Section 26b-299(a)(2) of CUSA; controlling person liability under Section 36b-29(c) of CUSA; and aided and abetted common law fraud. Fraser moved to dismiss all claims against him.

Control person. Plaintiffs plausibly pleaded that Fraser controlled GAW and Garza. Fraser owned half the company, a well-recognized indicator of control. He was involved in directing GAW’s major strategic decisions as well as the company’s daily operations. The plaintiffs pleaded with particularity that Fraser exercised actual control over the company’s decisions goes beyond the necessary elements to plead control person liability. Fraser was also Garza’s mentor from whom Garza regularly sought advice and approval before making decisions on the management and policies of their business which shows Fraser’s potential to influence and direct Garza and GAW. Fraser was also the leading creditor of GAW and Garza used that financial leverage in directing Garza’s actions.

It was not necessary to determine whether culpable participation is a state of mind requirement subjecting the claim to the PSLRA for purposes of the present matter because the complaint was sufficient either way. Fraser was aware of the information that contradicted GAW’s public statements about its services. Fraser had detailed conversations regarding GAW’s cloud mining offering and was aware that GAW was selling more mining capacity than it actually owned and paying new customers with the fees paid by earlier customers, a clear indicator of fraud. Fraser was also aware of operational deficiencies within GAW and the effect on the day-to-day running of the business, a strong indicator of recklessness. As such, pleadings were sufficient to find Fraser had culpable participation in the alleged fraud. The complaint also alleged Fraser personally orchestrated aspects of the fraud. In all, the pleadings were sufficient to deny Fraser’s motion to dismiss the control liability claims.

State law claims. The suit alleges Fraser aided and abetted Garza and GAW by providing capitalization and financing as well as providing business advice and direction; using his son as a sham CEO of a cloud mining company GAW then purported to purchase; soliciting potential investors in GAW; providing Cantor Fitzgerald resources for GAW’s benefit; and creating the cloud mining business model. The court found that the complaint contained sufficient facts that indicate Fraser’s public involvement with GAW and Garza as well as Fraser’s position with a major investment bank influenced purchasing decisions of others. The complaint supported the view that Fraser was a partner in GAW and a de facto board member as well as alleging he was a culpable participant sufficiently to support the claim that he was a controlling person under Connecticut state law. The allegations showing Fraser was a culpable participant for purposes of Section 20(a) were also sufficient to state a claim for aiding and abetting common law fraud. As such, Fraser’s motion to dismiss the state law claims was denied.

The case is No. 3:16-CV-940 (MPS).

Attorneys: Colin M. Watterson (Susman Godfrey LLP) for Denis Marc Audet. Daniel H. Weiner (Hughes Hubbard & Reed LLP) for Stuart A. Fraser.

MainStory: TopStory CorporateGovernance DirectorsOfficers FraudManipulation SecuritiesOfferings ConnecticutNews

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