Microcap liquidation schemes: Alberta Securities Commission finds Kilimanjaro Inc., its CEO and ‎behind-the-scenes control person breached securities laws in pump and dump scheme

The Alberta Securities Commission (“ASC”) recently released a rare decision on market manipulation against Kilimanjaro Capital Ltd. (“Kilimanjaro”) and related individuals. The ASC concluded that Kilimanjaro and Ashmit S. Patel, (“Patel”) a US resident who practised law in Illinois, and Zulfikar Rashid (“Rashid”), an Alberta resident, breached Section 93(a)(ii) of the Alberta Securities Act for engaging or participating in action that resulted in an artificial price for a security. The ASC also found that Patel was in breach of 93(a)(i) for engaging in action that created or contributed to a false or misleading appearance of trading activity. The market manipulation scheme took place between November 2012 and October 2014.

Market manipulation

Market manipulation may take many forms, including what is colloquially known as a “pump and dump” scheme, which as described by the ASC’s expert in this decision involves the following ingredients: “secret control over the issuer and a substantial block of its shares, direction of a promotion replete with falsehoods and exaggerations (the pump) and the concurrent liquidation of shares (the dump)”.

The ASC has previously described an “artificial price” as a “price that differs from the price that would result from the market operating freely and fairly on the basis of information concerning true market supply and demand”.

False or misleading appearance of trading activity may or may not be directed at creating an artificial price. The ASC has stated that the assessment of whether a set of trading orders reflects bona fide investment decisions involves considerations of motivation — that is, trading activity motivated by something other than bona fide investment intent would project a distorted image of demand or supply (or both), misinforming observers and the capital market generally by a “false or misleading appearance of trading activity”.

The British Columbia Securities Commission has enumerated several “hallmarks of market manipulation” including the following:

• wash trades (trades with no change of beneficial ownership)‎;
• trading with the object of inducing others to purchase;
• trades or orders that lead to an artificial price for a security;
• trades or orders that create a misleading appearance of trading activity;
• orders made without a bona fide intention to deliver the cash or securities necessary to ‎settle the trade;
• trades through nominee accounts;
• pre-arranged trades;
• market domination;
• uptick trades;
• involvement in opening and closing trades;
• high closing; and
• uneconomic trading.

Facts

The business of Kilimanjaro involved acquiring future contingent oil and mineral rights in Africa made with several governments in exile (“FCAs”). The contingency involved with these rights was that they were connected with the self-determination of the nations where the FCAs were located. Kilimanjaro was listed on the GXG (the European regulated market), and traded on the off-exchange over-the-counter (OTC) markets.

The ASC noted that the market manipulation was driven by the actions of Patel. The leadership of Kilimanjaro, particularly Rashid, were mere figureheads, and played no significant role in managing the company. Patel put himself out as Kilimanjaro’s legal counsel or Chief Operating Officer at different times, but the ASC found that Patel was the guiding mind of the entire company. Patel was involved in promoting the shares of Kilimanjaro using news releases and promotions including ‎unsupported share price projections and valuations of their current assets. At the same time, Patel, ‎through Rashid and others, was able to gain unfettered ability to share Kilimanjaro shares through a US based ‎brokerage account. ‎From the US brokerage account and other accounts under his control, Patel proceeded to make significant ‎trades of Kilimanjaro shares concurrently with the dissemination of promotional news releases ‎authored by him. Patel sold more than 113.5 million shares.

Not long after Patel’s systematic selling of his position and cashing out of Kilimanjaro, the name and business of ‎the company changed to nanotechnology. Although the company used the same address as Kilimanjaro and listed Patel as legal counsel, the future audited financial statements in 2013 and 2014 contained no references to Kilimanjaro or the FCAs in future press releases.

The decision

The ASC determined that Patel engaged in a microcap ‎liquidation scheme. These schemes occur when a small group of individuals enable ‎undisclosed control persons to engage in promotion of a security to stimulate demand, while ‎simultaneously liquidating the issuer’s shares into the market. According to the expert, these schemes require that undisclosed persons have control over an issuer while the officers and ‎directors are mere nominees who take direction and don’t engage in the day-to-day business of the ‎company. Additionally, these schemes require the same control persons to have control and influence ‎over securities transactions, so they can transfer shares to brokerage accounts and ultimately liquidate ‎them. ‎

Patel was the guiding mind of Kilimanjaro. He sought funding for the company, spoke ‎on its behalf, authored news releases and coordinated the company’s listing and promotional campaign. ‎Patel, through manipulation of and complacency by Rashid and other actors, gained unfettered authority to ‎control Kilimanjaro’s share capital and to instruct Kilimanjaro’s transfer agent. Patel was then involved in ‎promoting and inflating the value of Kilimanjaro’s share price, by crafting promotional news releases and ‎coordinating the promotional campaign. Before unloading the majority of his position, and during the promotional ‎campaign, Patel bought 100,000 shares of Kilimanjaro. This made up for the majority of market activity on that day, presenting a false uptick in ‎the share value. The ASC concluded that this purchase contributed to a misleading appearance of trading activity in Kilimanjaro shares due to several factors:

1. the purchase occurred at higher prices than the closing price only a few days earlier, and the shares were trending down;
2. the purchase was largely uneconomic, given that Patel sold more shares a few days later, at prices equal to or less than he purchased them;
3. the purchase did not meaningfully increase his shareholdings;
4. Patel made no other purchases during the promotional campaign, and he sold more than 33 million shares from his account before and after the purchase;
5. the purchase occurred during the promotional campaign, and coincided with 13 touts on the same day and several news releases in the same time period; and
6. the purchase constituted virtually all of the market activity on Kilimanjaro shares that day.

Patel was found in breach of 93(a)(i) of the Securities Act for creating a misleading appearance of trading activity. Kilimanjaro was not found in breach of this section as the ASC could not conclude that a corporation is responsible for market manipulation solely for being the issuer of securities that are subject to a misleading appearance of trading activity. Both Patel and Kilimanjaro were found in breach of 93(a)(ii) of the Securities Act  for contributing to the artificial price of a security due to the promotional campaign performed by Patel on Kilimanjaro’s behalf. The ASC also found that Kilimanjaro and Patel violated the Securities Act’s prohibitions against misrepresentations by issuing news releases regarding the assets of the corporation and the value of the FCAs misleading.

Rashid was also found in breach of 93(a)(ii) because of his involvement and complicity in‎ the impugned actions. As director and CEO, the ASC determined that he ought to have known ‎the manipulation being orchestrated by Patel. Rashid gave Patel complete control of the company and granted Patel ‎the right to use his signature on behalf of the company. This granted legitimacy to contracts and press ‎releases authored by Patel. Rashid also gave Patel unfettered authority to control the share capital of ‎Kilimanjaro. The ASC also noted that Rashid was warned by another party that the business being conducted by Patel had all the ‎signs of a scam.

Rashid was also found in breach of Section 221.1(2) of the Securities Act for misleading an ASC investigation. Rashid was questioned several times during the ASC investigation, and he admitted to providing untrue information, and the ASC found these untrue statements material to the investigation.

This decision also analysed the conduct of two other parties, Jonathan Levy and Gregory Scott Buczynski. Mr. Levy was a key member to the business of Kilimanjaro, and negotiated the FCAs for Kilimanjaro. The ASC could not tie his actions to the market manipulation scheme. Mr. Byczynski’s audit firm audited Kilimanjaro’s financial statements. The audited financial statements attached to the prospectus which allowed Kilimanjaro shares be listed on the GXG contained an apparently fraudulent capital raise of $8,000,000.00. The ASC similarly was not able to conclude that the actions of Byczynski were connected to the market manipulation.

During the next phase of the hearing, the ASC will render its decision on what sanctions will be imposed on Kilimanjaro, Patel and Rashid.

Takeaways

The Kilimanjaro decision is a rare case where market manipulation was found to have occurred, and suggests that the ASC and other securities regulators in Canada may be monitoring carefully for suspected “pump and dump” schemes.

The case did not involve the use of social media driven market manipulation; however, regulators such as the British Columbia Securities Commission (the “BCSC”) have made it clear they were pursuing new rules to strengthen their powers to prosecute those who use social media platforms to orchestrate market manipulation schemes. According to Peter Brady, the Executive Director of the BCSC, “the pump and dump game has changed,” adding that traditional enforcement tools “may not be up to the task in a world dominated by social media”. Legislative amendments to the British Columbia Securities Act passed last spring removed the need to prove that a misrepresentation had an effect on share price. This amendment lowers the threshold that the BCSC needs to meet to establish market manipulation. The BCSC has also indicated that it plans to unveil new regulations to expand disclosure requirements for anyone recommending buying or selling stock via social media.

Market manipulation has received increased attention in the media lately in the context of the extreme price movement in stock prices of AMG, BlackBerry and GameStop due in large part to discussions on social media platforms such as YouTube and Reddit, prompting the Canadian Securities Administrators (the umbrella organization of Canada's provincial and territorial securities regulators) and the Investment Industry Regulatory Organization of Canada to issue a joint statement warning that they will take appropriate regulatory action if abusive or manipulative trading activity is identified. It remains to be seen if other Canadian regulators will follow suit with the BCSC and introduce rules to facilitate enhanced enforcement action.

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