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Law360 (June 12, 2020, 5:04 PM EDT) -- A $25 million pump-and-dump stock fraud scheme duped investors with bogus claims that shell companies could make face masks or produce contactless vending machines during the COVID-19 pandemic, federal prosecutors and securities regulators in Massachusetts said.
The five Canadian citizens who orchestrated the scheme now face civil stock fraud claims brought by the U.S. Securities and Exchange Commission, according to a complaint that was unsealed Thursday by a federal judge in Massachusetts. Prosecutors also brought criminal charges against one of the defendants, Shane Schmidt, for securities fraud and conspiracy, according to a complaint unsealed Wednesday.
In the detailed civil complaint, the SEC unraveled how Schmidt, Nelson Gomes, Michael Luckhoo-Bouche, Kelly Warawa and Douglas Roe allegedly used a web of mainly Hong Kong-registered entities to buy penny stocks while hiding their insider ownership and evading securities rules.
The group inflated the stocks' value through email promotions and by boosting sales through the old-fashioned method of cold-calling investors, prosecutors said. The defendants then dumped the shares, walking away with millions of dollars, according to the SEC lawsuit.
The five defendants "defrauded ordinary investors by misleading them to believe that they were purchasing shares in the ordinary course of the market, when — in reality — the shares being offered were being dumped by company insiders," the SEC said.
Prosecutors said Schmidt fraudulently took control of a fake clothing company called Sandy Steele Unlimited Inc., listed the company for sale on the market and profited from the sale of its shares. According to the government, Sandy Steele promoted itself as a company that made clothing "but also has the possibility to manufacture health masks at those same facilities."
In reality, Sandy Steele had no inventory, revenue or other assets and had copied the products displayed on its website from images elsewhere on the internet, according to the SEC lawsuit.
The SEC puts Gomes at the center of the group's fraud, including the Sandy Steele transactions, saying he arranged for the stock sales to avoid the required public registration statements that could have tipped investors off to the shares being sold by insiders.
Regulators said that from June 2018 to the present, Gomes and Luckhoo have made more than $25 million on illegal stock sales through their entities, FFS Capital Ltd. and Paifang Trading Ltd.
Roe, a Vancouver resident, faced similar fraud charges from the SEC in 2017, settling the case in 2018 with a $50,000 fine and a permanent ban from trading penny stocks.
In the case of WOD Retail Solutions — a purported vending machine company owned in part by Gomes — the company successfully boosted its stock price in early 2020 by claiming its equipment was a solution for retailers seeking to do business in the COVID-19 era. In reality, it reported owning only three machines and having no revenue.
The SEC claims the group committed fraud in the stock sales and violated registration and reporting rules. Chief U.S. District Judge F. Dennis Saylor IV on Wednesday issued a temporary restraining order freezing the assets of the five defendants and barring them from selling any stock.
"Microcap stocks can be particularly vulnerable to manipulative schemes, and investors should be alert to the heightened risks that exist during this national emergency," Paul Levenson, director of the SEC's Boston office, said in a statement.
The trading entities controlled by the defendants listed in the civil complaint are Hong Kong-based FFS Capital Ltd., Hong Kong-based Paifang Trading Ltd., Canadian firm Atlantean Management Corp., Hong Kong-based Artefactor Ltd., Hong Kong-based Meadow Asia Ltd., and Hong Kong-based Thyme International Ltd.
In the criminal case over Schmidt's alleged involvement with Sandy Steele, prosecutors say he took the alias John Scott and filed falsified change-of-control paperwork with OTC Markets, a trading service for penny stocks. He claimed the company was a direct marketer of "anti-aging health and beauty products," and he designed a scheme of issuing shares to his affiliate companies that wouldn't be subject to the usual restrictions for affiliate-owned shares, prosecutors said.
By late 2019, Sandy Steele said it had shifted into the "wearable tech" business and was selling cold-weather clothing, though it reported no sales, according to the criminal complaint.
Investigators tracked Schmidt's involvement with Sandy Steele though his computer's IP address, details on "John Scott's" application to an OTC Markets service and payment records to the trading service, the government said.
A spokeswoman for prosecutors declined to comment on the complaint.
The government is represented in the criminal case by James R. Drabick of the U.S. Attorney's Office for the District of Massachusetts, and in the civil case by Eric A. Forni and Kathleen Burdette Shields of the U.S. Securities and Exchange Commission.
Counsel for the defendants was not immediately available Friday.
The cases are U.S. v. Schmidt, case number 1:20-mj-06415, in the U.S. District Court for the District of Massachusetts, and SEC v. Gomes et al., case number 1:20-cv-11092, in the U.S. District Court for the District of Massachusetts.
--Editing by Alyssa Miller.
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