Penny stock promoter First Resource Group LLC and its principal David H. Stern were charged with three counts of fraud by the Securities and Exchange Commission (SEC) in a complaint filed on Jan. 26.
The SEC Complaint
Stern and his Florida company fraudulently manipulated the market for the stock of two small, thinly traded companies, the complaint alleges.
While Stern pushed the stock to investors — mostly stockbrokers — through a telemarketing scheme, he was dumping the stock held by his company without informing the investors, an activity known as scalping. This market manipulation scheme allegedly ran from December 2008 through May 2010.
The companies were TrinityCare Senior Living Inc., which develops long-term care and senior living facilities, and Cytta Corp., which develops software for the transmission of medical data. Neither of these companies enjoyed good prospects at the time of the stock sales, according to the complaint, which was filed in U.S. District Court for the Southern District of Florida.
By purchasing small amount of the stock at above market rate, Stern created the false appearance that the markets for the stocks were liquid and active as a way to induce investors to buy, the complaint says. Stern also instructed First Resource’s telemarketers to make statements about the companies’ prospects that had absolutely no basis in fact.
For example, the telemarketers projected that TrinityCare’s stock price would rise to between $5 and $7 per share within a year. This projection was made when the stock was trading no higher than $1.95 and the defendants had no reasonable basis for their projection. In fact, after Stern stopped manipulating the market, TrinityCare’s share price dropped to 41 cents per share.
Scalping the stock of both companies netted First Resource about $169,000 that Stern transferred from First Resource’s brokerage accounts into his personal account, the complaint says.
Based in Fort Lauderdale, Fla., First Resource is a limited liability company formed by Stern in September 2008 to promote penny stocks. The company has never been registered with the SEC in any capacity and has never registered any offering of securities.
Stern, a resident of Tamarac, Fla., was First Resource’s sole manager during the alleged scheme. He was not associated with any registered stockbroker or broker-dealer during the time covered by the complaint.
Three Counts of Fraud Against Stern & First Resource Group
The three counts of fraud in the complaint list multiple violations of the Securities Act of 1933, and the Securities Exchange Act of 1934. They variously state that Stern and his company sold securities using the instruments of interstate commerce and the U.S. mail to knowingly or recklessly employ devices, schemes or artifices to defraud investors.
In addition, the complaint alleges that Stern and his company obtained money or property by means of untrue statements of material facts, through omissions of material facts, and engaged in a course of business which operated as a fraud or deceit upon purchasers and prospective purchasers of the relevant securities.
The complaint also includes a count for Stern’s failure to register with the SEC as a broker or dealer when neither he nor his company were associated with any registered entity.
The suit is seeking disgorgement of Stern’s ill-gotten gains as well as prejudgment interest and civil money penalties. The SEC also seeks to bar Stern from participating in offerings of penny stock in any way, plus declaratory and permanent injunctive relief.
The alleged market manipulation scheme began when First Resource signed contracts with stock promoters agreeing to solicit investors in the two companies. First Resource received 150,000 shares of TrinityCare stock and 200,000 shares of Cytta stock as compensation.
First Resource then hired telemarketers to cold-call investors and recommend the penny stocks at the same time that Stern was selling the shares. Stern eventually transferred about $169,000 in proceeds from his company’s brokerage accounts to his personal bank account, the complaint says.
Stern had a lot of control over the process, the complaint says. He furnished the information used by the telemarketers, edited the draft scripts, and approved them before use. Stern also gave the telemarketers a database of registered stockbrokers to pitch.
The information the telemarketers used to push the stock was filled with material misrepresentations to investors, the complaint says.
Regarding TrinityCare, the telemarketers touted the company’s rapid revenue growth and projected that the stock would appreciate by $5 or $6 in six months to a year, as well as predicting it rise to $40 in five years.
In addition, Stern sent out a research report on TrinityCare that said it would post a profit on revenues exceeding $7.2 million for 2009. The report — as well as the telemarketers — also claimed the company was on track to add four new senior living facilities, that it had secured $50 million in financing to construct these facilities backed by the U.S. Department of Housing and Urban Development.
None of these claims had any reasonable basis in fact, according to the complaint.
“Stern knew, was severely reckless in not knowing, or should have known, that TrinityCare had lost money for the previous two years and had no realistic prospects of revenues,” the complaint says. Stern also either knew or should have known that TrinityCare had not obtained financing for its new facilities, and that it was only at the pre-application stage to obtain HUD financing.
Moreover, Stern was manipulating the market and selling First Resource’s TrinityCare stock for his personal financial gain while these material misrepresentations were being fed to investors, the complaint says.
First Resource and Stern also made material misrepresentations regarding Cytta, sending out a research report that projected total sales revenue of more than $500 million for 2010 to 2014.
These statements were misleading, according to the complaint. Cytta had not made a profit since its launch in 1997. In fact, for the year ended Dec. 31, 2008, the company revenues reached only $35,000, and it posted a net loss of $70,000. The company’s auditors’ had even expressed doubts in an SEC filing that Cytta could continue to operate.
In the meantime, Stern was personally benefiting from the sale of Cytta stock, all while he and First Resource were making these material misrepresentations, the complaint says.
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