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SECURITIES AND EXCHANGE COMMISSION

Litigation Release No. 16270 / September 2, 1999

Securities and Exchange Commission v. Lawrence J. Penna, Herman Epstein and Douglas J. Mangan No. 99 Civ. 9406 (S.D.N.Y.)

Former Principals and Branch Owner of New Jersey Broker-Dealer Settle Charges in Massive Microcap Securities Fraud

The Securities and Exchange Commission ("Commission") today filed a civil action arising from a massive securities fraud that was conducted through Investors Associates, Inc. ("Investors Associates"), a now-defunct broker-dealer. In today's Complaint, which was filed in federal court in Manhattan, the Commission charged the former owners of the firm and former co-owner of its most active branch with obtaining illegal profits totaling over $33 million by underwriting fraudulent public offerings of securities of five companies and manipulating the market prices of those securities between 1995 and 1997.

Named in the Commission's Complaint are:

Lawrence J. Penna ("Penna"), formerly known as Lawrence Joseph Pennacchio, age 56, of New York, New York, who, at the time of the transactions and events alleged in the Complaint was the President and CEO of Investors Associates.

Herman Epstein ("Epstein"), age 58, of Franklin Lakes, New Jersey, who, at the time of the transactions and events alleged in the Complaint, was Chairman and Compliance Director of Investors Associates.

Douglas J. Mangan ("Mangan"), age 37, of Amityville, New York, who, at the time of the transactions and events alleged in the Complaint, was the co-owner of the largest, most active, and most profitable office of Investors Associates, located in Melville, New York.

According to the Complaint:

Investors Associates was a Hackensack, New Jersey broker-dealer registered with the Commission since 1969, which, at the relevant time, had approximately 17 branch offices employing approximately 500 registered representatives.

The Manipulative Scheme

Beginning in 1995, Penna and Epstein agreed to use Investors Associates as part of a scheme to conduct fraudulent offerings for a series of companies and to manipulate the market in these securities. They were approached by other individuals who secretly controlled a second broker-dealer and who offered to provide the "product" -- securities of issuers eligible for a NASDAQ SmallCap listing -- that they would jointly manipulate. The scheme had the following characteristics:

  • To create a supply of securities to be sold into the manipulated market, before each offering the company issued an enormous piece of equity in the form of warrants to "bridge lenders." Investors Associates would designate a bridge lender who would receive certain of the bridge warrants. In addition, "founders" of the issuers, most of whom were associates, relatives, or nominees of the participants in the scheme, would obtain large blocks of shares of the issuer for pennies per share before the offering.
  • A relatively small amount of newly issued securities were sold by the issuer in the underwriting. Although that limited the capital available to the issuer, it made it easier for the manipulators to maintain control of the supply of free-trading stock after the offering.
  • Most of the bridge lenders' and founders' securities were registered for eventual resale in the same registration statement that registered the newly issued securities that were sold in the underwriting. Before each underwriting, Epstein and Penna reached agreements for Investors Associates to purchase large blocks of the bridge lenders' and founders' securities at a substantial discount to the underwriting price.
  • As the offering date neared, Investors Associates' sales forces solicited orders for the securities through an aggressive selling effort in which neither the manipulative scheme nor material negative information concerning the offered securities was disclosed to customers. Customers were directed to send in their money before the offering date to ensure that they would receive some shares at the offering price.
  • Investors Associates and the second broker-dealer split the aftermarket retail activity, in order to create the appearance that no firm dominated and controlled the market, as part of an effort to evade the rules of the federal securities laws prohibiting fraudulent mark-ups.
  • Immediately after the offering, Investors Associates and other broker-dealers systematically coordinated their quotes and trading to move the price of the newly issued securities to a predetermined target price of approximately double the offering price. Penna directed the trading and bid coordination on behalf of Investors Associates.
  • Once the target price was achieved, Investors Associates filled most of each pre-solicited customer order at that inflated price. Investors Associates covered its resulting short position with the bridge lenders' and founders' securities it purchased at a fraction of the initial offering price.

Investors Associates co-underwrote five offerings in accordance with the fraudulent scheme: Interiors, Inc., Compare Generiks, Inc., Perry's, Inc., Decor, Inc., and Superior Supplements, Inc. All of the issuers had little history of earnings, and dim prospects. All but one of the issuers had received audit opinions before their offerings that were qualified due to uncertainties about their abilities to continue as going concerns. Penna and Epstein knew that the issuers were not likely to succeed as viable businesses. All of the issued securities except Interiors are now virtually worthless, quoted at prices ranging from 2 cents to 63 cents each. Investors Associates reaped at least $33 million in illegal profits from trading in the securities of the five issuers.

The Melville Office

The execution of the fraudulent scheme required an organized and effective sales force to sell the manipulated securities to unsuspecting investors. The Melville, New York office of Investors Associates, the largest, most active, and most profitable of the offices, was integral to the scheme. Mangan owned a 50 percent interest in the Melville office, which employed more than 300 cold callers and representatives, in what is most aptly described as a "boiler room" or "bucket shop." Mangan rigorously trained his brokers to use a panoply of abusive sales practices to generate orders and then prevent customers from selling the manipulated shares. These practices included:

  • Recommending an initial investment in a blue chip stock to first "hook" the client with what appeared to be solid investment advice, and then persuading the client to switch his investment to an Investors Associates-underwritten "house stock;"
  • Making outrageous claims about the business prospects of the house stock, often read from a script, and never disclosing the substantial risks of the investment or the underlying facts of the manipulative scheme;
  • Simply selling the initial investment and purchasing the house stock without authorization from the client if an order could not be obtained;
  • Refusing to take or declining to execute sell orders.

The Settlements

Simultaneously with the filing of the Complaint Penna and Epstein, without admitting or denying the Commission's allegations, settled the action by consenting to the entry of a permanent injunction from violations of Sections 5(a) and 17(a) of the Securities Act of 1933 ("Securities Act"), Sections 10(b) and 15(c) of the Securities Exchange Act of 1934 ("Exchange Act") and Exchange Act Rules 10b-3, 10b-5, 15c1-2 15c1-8 and Regulation M and an order requiring them, jointly and severally, to disgorge illegal profits of $33,184,125, provided that upon Epstein's disgorging $25,000, collection of the remaining disgorgement will be waived in light of Penna's and Epstein's demonstrated inability to pay based upon their sworn representations in their statements of financial condition.

Simultaneously with the filing of the Complaint Mangan, without admitting or denying the Commission's allegations, settled the action by consenting to the entry of a permanent injunction from violations of Sections 5(a) and 17(a) of the Securities Act, Section 10(b) of the Exchange Act and Exchange Act Rule 10b-5 and an order requiring him, jointly and severally, to disgorge illegal profits of $10,140,000, provided that upon Mangan's transfer of 294,170 shares of Tal Wireless Networks, Inc., collection of the remaining disgorgement will be waived in light of Mangan's demonstrated inability to pay based upon his sworn representations in his statement of financial condition.

In a parallel criminal proceeding, the United States Attorney for the Southern District of New York today filed criminal informations charging Penna and Epstein with perjury before the Commission's staff during its investigation and charging Penna, Epstein, and Mangan with securities fraud in connection with the five fraudulent offerings, as well as other crimes.

* * *

This enforcement action is part of the Commission's four-pronged approach to attacking microcap fraud: enforcement, inspections, investor education and regulation. For more information about the Commission's response to microcap fraud, visit the Commission's Microcap Fraud Information Center at http://www.sec.gov/news/extra/microcap.htm

http://www.sec.gov/litigation/litreleases/lr16270.htm


Modified:09/08/1999