Greyline Insights – Q2 2019 « Greyline Partners, LLC

Greyline Insights – Q2 2019

In this Issue

Greetings from London! Following the launch of Greyline’s U.K. office in the first quarter, I have been asked to introduce this second edition of Greyline Insights to give a global perspective on the key regulatory developments of Q2 2019.

In perhaps the biggest U.S. regulatory development in some time, the SEC voted to adopt the long-awaited Regulation Best Interest and Form CRS (i.e., Form ADV Part 3), which directly reflect the Commission’s current emphasis on retail consumer protection. Also worth noting, the SEC and CFTC have both maintained active pipelines of enforcement and whistleblowing cases this quarter, and the SEC’s Office of Compliance Inspections and Examinations (OCIE) published a Risk Alert on privacy and third-party network storage. Additionally, a U.S. federal court recently upheld an SEC decision finding that the word “may” was insufficient to adequately disclose a preexisting conflict of interest, which further validates the stance the SEC has taken in recent years.

On this side of the pond, the deepening uncertainty around Brexit continues to be a key theme. After a flurry of contingency planning in Q2 linked to the proposed U.K. withdrawal agreement, the resignation of the U.K. Prime Minister Theresa May and the ongoing leadership contest have thrown the agreement into doubt. A peculiar side effect of this is that U.K. firms are now having to grapple with how to implement new E.U. regulations at short notice, which weren’t expected to apply. The revised Shareholder Rights Directive and EMIR Refit, at the end of this newsletter, are both examples of this.

The impact of Brexit on U.S. firms is less, however, cross-border asset raising and GDPR compliance are two examples of where there may be some impact.

Nick Thomas
Partner, Greyline

FEATURE

SEC Adopts Rules and Interpretations Regarding Regulation Best Interest, Form CRS Relationship Summary, Investment Adviser’s Fiduciary Duty and Broker-Dealer Exclusion

On June 5, 2019, the Securities and Exchange Commission (SEC) approved a set of rules and interpretations targeting the standards of conduct to which broker-dealers and investment advisers will be held. These actions include new Regulation Best Interest, the new Form CRS Relationship Summary, and two separate interpretations under the Investment Advisers Act of 1940, as amended (“Advisers Act”).

Regulation Best Interest modifies the standard of conduct for broker-dealers which will now be required to act “in the best interest of their retail customers when making a recommendation,” as opposed to operating purely on the basis of suitability. The regulation also makes it clear that a broker-dealer may not place its own financial interests ahead of those of retail customers. Broker-dealers will be required to establish, maintain, and enforce policies and procedures reasonably designed to comply with the rule. Moreover, the newly-adopted Form CRS Relationship Summary will require investment advisers and broker-dealers to provide retail investors with a summary containing information about (1) the services the firm offers, (2) fees, (3) costs, (4) conflicts of interest, (5) legal standard of conduct, and (6) whether the firm and its financial professionals have disciplinary history. While facilitating layered disclosure, the format of the relationship summary allows for comparability among the two different types of firms in a way that is distinct from other required disclosures. Both Regulation Best Interest and Form CRS will be effective 60 days after they are published in the Federal Register with a transition period lasting until June 30, 2020.

In addition, the SEC also published an interpretation that reaffirms and clarifies its view of the fiduciary duty that investment advisers owe to their clients. The interpretation generally elaborates on established principles behind the duties of loyalty and care and clarifies that while the application of the fiduciary duty can be affected by the defined scope of the adviser-client relationship, it cannot be waived as per Section 215 of the Advisers Act. Finally, the SEC issued an interpretation of the “solely incidental” prong of the broker-dealer exclusion under the Advisers Act, which is intended to more clearly delineate when a broker-dealer’s performance of advisory activities causes it to become an investment adviser within the meaning of the Advisers Act. Specifically, it states that a broker-dealer’s advice as to the value and characteristics of securities or as to the advisability of transacting in securities is included in the “solely incidental” prong of this exclusion if the advice is provided in connection with, and is reasonably related to, the broker-dealer’s primary business of effecting securities transactions. Both interpretations will become effective upon publication in the Federal Register.

Regulatory Updates

SEC Charges Former CEO of Silicon Valley Startup With Defrauding Investors

OnApril 2, 2019, the SEC charged and settled with Daniel Mattes, former CEO of Silicon Valley mobile payments startup Jumio, with defrauding investors by providing them with materially misleading information. The SEC’s complaint alleges that Mattes overstated 2013 and 2014 revenues, then sold roughly $14 million worth of his own shares to investors on the secondary market. He falsely told one investor that he was not selling his own interests because “great stuff was coming” and “he’d be stupid to sell at this point.” Likewise, Mattes hid these sales from Jumio’s board of directors. In 2015, Jumio restated its financial results to say it had made $17.2 million in gross revenues across 2013-14, instead of the $251 million that Mattes allegedly claimed. Jumio then went bankrupt in 2016, making the shares worthless. Mattes agreed to a settlement and will pay more than $17 million. The SEC also settled a separate case against former Jumio CFO Chad Starkey concerning his oversight of financial statements, as well as signing documents with false claims relating to Mattes’ stock sales. Starkey has been ordered to pay more than $350,000 for his role.

SEC Settles Insider Trading Charges Against Pharma Company Accountant, Three Others

On March 19, the SEC obtained final judgments against former Celator Pharmaceuticals Inc. CPA Evan R. Kita, as well as Daniel Perez, Richard Yu and Chiang Yu, in an insider trading scheme. The SEC alleged that Kita provided confidential information about Celetaor to Perez and Richard Yu – the latter of which passed those tips on to his father, Chiang Yu; all three bought Celator shares after receiving the information. The SEC levied $442,006 in combined disgorgement and prejudgment interest payments against the four, and permanently suspended Kita from acting as an accountant before the SEC. The four also pled guilty to criminal charges brought by the U.S. Attorney’s Office for the District of New Jersey; Kita will serve six months in prison, while the other three will be placed on probation.

CFTC Staff Provides Further Brexit-Related Market Certainty

On April 5, 2019, the CFTC’s Divisions of Swap Dealer and Intermediary Oversight (DSIO), Market Oversight (DMO), and Clearing and Risk (DCR) issued two letters to provide market certainty regarding Brexit – the withdrawal of the United Kingdom from the European Union. “The first letter ensures that existing regulatory relief provided by DSIO, DMO, and DCR pursuant to certain staff letters affecting EU entities continues to be available for U.K. entities following Brexit. In the second letter, DSIO and DMO provide time-limited no-action relief to ensure the continued availability, following Brexit, of substituted compliance and regulatory relief under certain existing CFTC comparability determinations and exemption orders originally issued by the CFTC for EU entities, while CFTC staff undertakes an analysis of U.K. law in order to make appropriate recommendations of comparability or exemption to the CFTC.”

SEC Brings Actions Against 15 Unregistered Brokers for Their Participation in an Illegal Offering of Microcap Securities

On April 9, 2019, the SEC charged 15 people for their alleged roles in fraudulent, unregistered securities offerings by Intertech Solutions, Inc. The SEC’s complaints allege that Intertech hired more than a dozen individuals – notably, none of whom were registered brokers – to facilitate a cold-calling operation that raised more than $7 million from retail investors between February 2014 and December 2016. The complaints say Intertech paid “exorbitant commissions” between 35% to 50%, but that private placement memoranda indicated only 10% of investor proceeds would be used as commissions. Eleven of the defendants have agreed to settlements. Intertech and its control persons previously were charged for their roles in the offerings.

SEC Charges Former SeaWorld Associate General Counsel With Insider Trading

On April 9, 2019, the SEC charged a now former senior lawyer at SeaWorld Entertainment Inc. (NYSE: SEAS) with insider trading. The SEC alleges that Paul B. Powers had early access to key nonpublic revenue information showing a strong financial performance “after a lengthy period of decline,” which he used in a swing trade. He bought 18,000 shares of SEAS shares the day after he received a confidential draft of said information. He sold those shares for approximately $65,000 in illicit profits following the release of the company’s financial report, which triggered a 17% gain in shares. On the same day, the U.S. Department of Justice announced charges against Powers concerning the same conduct.

SEC Charges Former Woodbridge Directors of Investment With Fraud

On April 11, 2019, the SEC charged Ivan Acevedo and Dane R. Roseman – two former directors of investments at Woodbridge Group of Companies LLC – for their roles in the company’s Ponzi scheme. Acevedo and Roseman were not registered with the SEC, yet they helped raised more than $1.2 billion from more than 8,400 retail investors, “many of them seniors,” the SEC’s complaint alleges. Together, they received at least $3 million in transaction-based and other compensation as a result of these activities. The complaint alleges that Acevedo and Roseman “knew or were severely reckless in not knowing” that they were participating in the scheme. The two oversaw Woodbridge’s sales department and ensured that sales agents followed a consistent sales pitch that was based on fraudulent information. Likewise, they communicated to Woodbridge owner Robert Shapiro sales figures and reported that the sales agents were sticking to the script. Shapiro, the company’s highest-earning unregistered brokers, and the company itself, were all previously charged for their roles in operating the Ponzi scheme.

Risk Alert: Investment Adviser and Broker-Dealer Compliance Issues Related to Regulation S-P – Privacy Notices and Safeguard Policies

On April 16, 2019, the Office of Compliance Inspections and Examinations (OCIE) provided a list of compliance issues related to an SEC rule (Regulation S-P) that deals with investment adviser and broker-dealer privacy notices and safeguards policies. OCIE provided several examples of deficiencies and weaknesses, including registrants not providing Initial Privacy Notices, Annual Privacy Notices and Opt-Out Notices to customers, and registrants with written policies that were not actually implemented. The PDF link below outlines the full list of common compliance issues.

SEC and FINRA to Hold National Compliance Outreach Program for Broker-Dealers on June 27, 2019

On April 16, 2019, the SEC and FINRA announced it was opening registration for the 2019 National Compliance Outreach Program for Broker-Dealers, scheduled for 9 a.m. to 3 p.m. CT on June 27, 2019, at the Federal Reserve Bank of Chicago. The SEC describes the program as providing “an open forum for regulators and industry professionals including compliance, internal audit, and other senior personnel of broker-dealer firms and branch offices, to discuss current compliance practices and promote a more effective compliance structure for the protection of investors.” The event is free, but in-person attendance is limited to 250 and will be awarded on a first-come, first-served basis. Firms are limited to four attendees each. A webcast of the event will be aired at https://www.sec.gov/news/webcasts.htm.

CFTC Approves a Final Rule to Provide Exception to Annual Privacy Notice Requirement

On April 19, 2019, the CFTC approved a final rule to revise CFTC Regulation 160.5 to remove a requirement to provide annual privacy notices when certain conditions are satisfied in accordance with the FAST Act’s statutory amendment to the Gramm-Leach-Bliley Act which grants such relief. This rule pertained to certain futures commission merchants, retail foreign exchange dealers, commodity trading advisors, commodity pool operators, introducing brokers, major swap participants and swap dealers. The final rule officially became effective on May 28, 2019 and is substantially similar to the current SEC requirements for registered investment advisers.

Silicon Valley Company Settles Fraud Charge for Misstating Returns to Investors

On April 19, 2019, the SEC announced that marketplace lender Prosper Funding LLC was penalized $3 million for “miscalculating and materially overstating annualized net returns to retail and other investors.” Prosper offers and sells securities linked to its consumer credit loans. However, the SEC says Prosper excluded certain non-performing charged off loans when it calculated returns that it reported to investors, resulting in overstatements of annualized net returns for more than 30,000 investors and used these figures when soliciting investors to increase their investment. Tens of thousands of investors made additional investments, in part, based on these figures, and Prosper also received additional fees based on these transactions. The order also finds that Prosper failed to identify the issue, although it knew employees did not properly know how to calculate returns and failed to correct the issue, despite investor complaints.

A Stark Warning on the Use of the Word “May” When Disclosing Conflicts of Interest

On April 20, 2019, the D.C. Court of Appeals, in Robare Group, Ltd., v. SEC, upheld an SEC decision that the word “may” in a disclosure regarding conflicts of interest related to revenue sharing is not sufficient. Robare is a Texas-based investment adviser who engaged Fidelity Investments in a revenue sharing agreement in 2004. Robare utilized Fidelity for execution, custody and clearing services and from 2005 to 2013, Robare received nearly $400,000 from Fidelity. In the initial 2011 version of its Form ADV Part 2A, the Firm stated that it “may” (emphasis added) receive selling compensation” and “may” (emphasis added) receive additional compensation in the form of custodial support services from Fidelity based on revenue from the sale of funds through Fidelity.” In 2015, the SEC alleged that these disclosures were inaccurate, but the case was dismissed by an administrative law judge. This was appealed the D.C. court which ruled that the use of “may” was not sufficient when the firm “is” receiving compensation. Therefore, Robare’s conduct was found to be negligent, however, the Court ruled that the rule was not “willfully” violated as the SEC initially argued.

In recent years, using “may” to describe present conflicts of interest has become a common deficiency in SEC examination findings. Advisers are strongly encouraged to periodically review their regulatory disclosure and offering documents for instances where “may” is used to discuss a preexisting arrangement and corresponding conflict.

CFTC Charges Forex Trading Firms and Principals in $75 Million Fraud

On April 22, 2019, the CFTC charged Oasis International Group, Limited (OIG), Oasis Management, LLC (OM), Satellite Holdings Company (Satellite), Michael DaCorta, Joseph Anile, II, Raymond Montie, III, Francisco “Frank” Duran and John Haas with operating a foreign currency trading scheme. The CFTC’s complaint alleges the defendants fraudulently received $75 million involving more than 700 U.S. residents from mid-April 2014 through the present for investment in two commodity pools (Oasis Pools), but deposited only $21 million into the two Oasis Pools, all of which they lost via trading. The defendants allegedly used $28 million to make Ponzi-like payments to pool participants, and spent more than $18 million for unauthorized personal or business expenses.

CFTC Proposes to Amend Derivatives Clearing Organization Regulations

On April 29, 2019, the CFTC green-lit a proposed rule to amend regulations applying to derivates clearing organizations (DCOs). In response to various questions regarding Part 39 of the CFTC’s regulations, which implement statutory core principles, the CFTC is trying to amend or clarify certain provisions. The proposal addresses certain risk management and reporting obligations, clarifies the meaning of certain provisions, simplifies registration and reporting processes, and codifies staff relief and guidance. This has been a part of an ongoing effort for the CFTC’s staff who have been working with DCOs’ concerns in this area. Likewise, it is a part of an agency-wide initiative called “Project KISS” to simplify agency rules, regulations, and practices.

Federal Court Orders Binary Options Firm and Principal to Pay More Than $22 Million for Fraudulent Scheme

On April 29, 2019, the CFTC imposed sanctions against Dr. Michael Shah and Zilmil, Inc. for engaging in a “large-scale internet fraud scheme” using off-exchange binary options. Zilmil, which claims to be one of the largest affiliate marketers in binary options, sent more than 60 million mass emails, containing false and misleading statements about performance, to more than 1.4 million unique email addresses in a seven-month period. CFTC has imposed a judgment of $22,854,289.69 million on both Shah and Zilmil, consisting of restitution awards and civil monetary penalties.

SEC Extends Compliance Dates for Rule 605 and 606 Reporting

The SEC announced that it will extend the compliance date for amendments to Rules 606 of Regulation NMS, which requires additional disclosures by broker-dealers to customers concerning the handling of customer orders. Following September 30, 2019, broker-dealers must begin to collect information required by Rules 606(a) and 606(b). The amendment to Rule 606(a) would allow for broker-dealers to make limited updates to public disclosure of their routing practices. Likewise, amendments to 606(b)(3) require that order handling reports include information on the customer’s not held NMS stock order flow with the broker-dealer. The extension is due in part to the SEC recognizing that broker-dealers may need more time to make the necessary changes to their systems and to test that they are in compliance with the amended rules.

CFTC Staff Issues Clearinghouse Supervisory Stress Test Report

On May 1, 2019, the CFTC’s Division of Clearing and Risk (DCR) and the Office of the Chief Economist (OCE) issued a report on the results of a reverse stress test of central counterparties or clearinghouse resources, as well as an analysis of stressed liquidation costs. CCP Supervisory Stress Tests: Reverse Stress Test and Liquidation Stress Testsays CME Clearing and LCH Ltd. had sufficient resources to cover their losses even if all their clearing members with losses defaulted under “extreme” scenarios. Moreover, an analysis of liquidation margin add-ons at CME Clearing and LCH Ltd. showed “either (central counterparty) would have sufficient pre-funded resources to cover stress losses resulting from the default of a house account, defined as an extreme market move as well as the liquidation of the account at a cost twice the anticipated cost.”

FINRA Sanctions AXA Advisors, LLC Approximately $772,000 for Misrepresentations to 401(k) Plan Sponsors and Participants

On May 2, 2019, FINRA announced AXA Advisors, LLC, has been fined $600,000 and ordered to pay another $172,000 in restitution for misrepresenting the portfolios of certain bond funds offered in 401(k) plans. Namely, between September 2010 and November 2015, AXA’s materials stated that five bond funds were “investment-grade” despite containing a “substantial portion” of high-yield (also known as “junk”) debt. AXA’s representatives work with retirement plan sponsors to determine which funds would be included in their offerings. One such plan was 65% invested in junk bonds as of March 31, 2015.

SEC Charges Sapphire Glass Manufacturer and Former CEO With Fraud

On May 3, 2019, the SEC charged New Hampshire based GT Advanced Technologies Inc. and its former CEO for misleading investors about its ability to deliver a key supply to Apple Inc. (NASDAQ: AAPL) and found that it misclassified more than $300 million in debt to Apple. The SEC’s order states that Apple agreed to advance $578 million across four installments to GT in exchange for “sapphire glass” for its iPhones, but Apple withheld some of that money because GT could not meet required standards. The agreement was closely watched by the market due to the fact that it would be highly material to GT’s value. However, then-CEO Thomas Gutierrez “falsely stated that GT expected to hit performance targets and receive the fourth installment payment from Apple by October 2014” and made other projections that caused GT to misstate certain financial results. GT filed for bankruptcy in October 2014.

CFTC Announces Approximately $1.5 Million Whistleblower Award

On May 6, 2019, the CFTC announced a roughly $1.5 million award to an individual whistleblower who prompted action from the CFTC and another federal regulator. The commission also lauded the whistleblower for seeking to report their concerns internally before coming to the CFTC. “While there is no requirement that a whistleblower report internally before approaching the Commission, today’s award demonstrates that the Commission may pay enhanced awards to those that do – that is one of the positive factors set out in our rules for the Commission to consider in making its award determination,” said Christopher Ehrman, Director of CFTC’s Whistleblower Office. CFTC has awarded more than $85 million to whistleblowers since it started issuing the award in 2014.

CFTC’s Division of Enforcement Issues First Public Enforcement Manual

On May 8, 2019, the CFTC’s Division of Enforcement (DOE) published its first Enforcement Manual. The manual is a general reference tool that DOE staff can use while investigating and prosecuting potential violations of Commodity Exchange Act (CEA) and CFTC regulations. It also provides the general public with more information about what the DOE does, and advances “the rule-of-law principles that underpin all DOE and CFTC enforcement actions.” The CFTC says the manual will be periodically revised and updated.

CFTC Charges CEO of Managed Fund With Misappropriation, Fraud, and Making False Statements to NFA

On May 10, 2019, the CFTC announced it filed a civil enforcement action charging Fabio Bretas de Freitas with fraud and misappropriation, as well as with making false statements to the National Futures Association. The CFTC alleges that Bretas de Freitas and Phy Capital Investments LLC (PCI) fraudulently solicited at least $7.8 million from various victims for his funds, falsely representing that the funds were invested and the returns they produced. The CFTC says “the only account traded by the defendants on U.S. exchanges was a proprietary account that lost over $85,000 and a managed account for a PCI employee that earned less than $150.” Breitas de Freitas also allegedly provided false statements to the NFA to keep the scheme going. He stated that one of PCI’s commodity pools was a private equity fund, and even set up a fake email pretending to be a lender for that fund so the NFA could speak to them. The CFTC is seeking full restitution and Bretas de Frietas was also indicted on criminal charges.

Jury Rules in SEC’s Favor, Finds Brokerage Firm and Two of Its Executives Liable for Fraud

On May 15, 2019, jurors in Manhattan federal court ruled in favor of the SEC against brokerage firm Portfolio Advisors Alliance Inc., as well indirect owner Howard J. Allen and PAA President Kerri L. Wasserman. The firm and the executives faced fraud and other charges in making “material misrepresentations and omissions in American Growth Funding II LLC’s private placement offering.” AGF II promised 12% annual returns and falsely claimed that its financial statements were being audited each year. In addition, PAA, Allen and Wasserman knew that the offering documents were incorrect but still utilized them. AGF II and owner Ralph C. Johnson were charged with lying to investors who purchased its high-yield securities.

SEC Obtains Emergency Order Halting Alleged Diamond-Related ICO Scheme Targeting Hundreds of Investors

On May 21, 2019, the SEC said it obtained an emergency court order halting a Ponzi scheme targeting more than 300 investors in the U.S. and Canada. A U.S. District Court granted a temporary restraining order and temporary asset freeze against South Florida-based Argyle Coin, LLC, and principal Jose Angel Aman, both of which were charged with using investor funds in a $30 million Ponzi scheme. The SEC also alleges the fraud is a continuation of a scheme orchestrated with Natural Diamonds Investment Co. and Eagle Financial Diamond Group Inc, both of which Aman also owns. Aman misused $10 million to pay investors and for personal expenses such as rent, horses and riding lessons for his son. “As alleged, Aman operated a complicated web of fraudulent companies in an effort to continually loot retail investors and perpetuate the Ponzi schemes as well as divert money to himself,” said Eric Bustillo, Director of the SEC’s Miami Regional Office.

SEC, NASAA and FINRA Issue Senior Safe Act Fact Sheet to Help Promote Greater Reporting of Suspected Senior Financial Exploitation

On May 23, 2019, the SEC, North American Securities Administrators Association (NASAA) and FINRA celebrated the one-year anniversary of the passage of The Senior Safe Act by issuing a fact sheet to help raise awareness. The Senior Safe Act protects “covered financial institutions” from liabilities stemming from reporting a case in which a senior citizen is potentially being exploited. The fact sheet includes several actions, including a Sept. 2018 charge in a $1 million scheme mostly targeting the elderly. “Several of the alleged victims were suffering from Alzheimer’s disease or other forms of dementia, and at least five of the victims passed away during the course of his fraud,” the fact sheet states. You can view the full fact sheet here.

SEC Sues Alleged Perpetrator of Fraudulent Pyramid Scheme Promising Investors Cryptocurrency Riches

On May 23, 2019, the SEC filed a civil injunctive action against Daniel Pacheco for his alleged role in a pyramid scheme, conducted through two California-based companies he controls: IPro Solutions LLC and IPro Network LLC (IPro). IPro raised more than $26 million through the sale of instructional packages teaching investors about e-commerce. However, investors also received points that were convertible into a digital currency, and IPro awarded cash and points to anyone who brought new investors into the IPro fold. The SEC alleges that the sale of the IPro instructional packages involved an unregistered sale of securities because it involved investing in a pyramid scheme, as well as digital assets (requiring registration with the SEC) The SEC also claims that Pacheco quickened his company’s collapse by using funds to buy things such as a $2.5 million home and a Rolls Royce. Ultimately, this led to his inability to pay commissions and bonuses to investors.

Risk Alert: Safeguarding Customer Records and Information in Network Storage – Use of Third Party Security Features

On May 23, 2019, the OCIE released a risk alert pertaining to security issues associated with storing electronic customer records and information by broker-dealers and investment advisers. Specifically, OCIE observed three concerns that may raise compliance issues:

“Misconfigured network storage solutions. In some cases, firms did not adequately configure the security settings on their network storage solution to protect against unauthorized access. In addition, some firms did not have policies and procedures addressing the security configuration of their network storage solution. Often, misconfigured settings resulted from a lack of effective oversight when the storage solution was initially implemented.

“Inadequate oversight of vendor-provided network storage solutions. In some cases, firms did not ensure, through policies, procedures, contractual provisions, or otherwise, that the security settings on vendor-provided network storage solutions were configured in accordance with the firm’s standards.

“Insufficient data classification policies and procedures. In some cases, firms’ policies and procedures did not identify the different types of data stored electronically by the firm and the appropriate controls for each type of data.”

OCIE encourages firms to review their data storage procedures and actively oversee their vendors to make sure they can meet their regulatory responsibilities.

SEC Awards $4.5 Million to Whistleblower Whose Internal Reporting Led to Successful SEC Case and Related Action

On May 24, 2019, the SEC rewarded a whistleblower whose actions caused a company to review allegations of significant wrongdoing and send a report about those allegations to the SEC and another agency. The whistleblower actually submitted an anonymous tip both to the company and the SEC. However, the company self-reported the allegations, resulting in an SEC investigation. After reviewing the company’s internal investigation and conducting its own review, the SEC ultimately moved forward with an enforcement action. “The whistleblower gets credit for the company’s internal investigation because the allegations were reported to the Commission within 120 days of the report to the company,” says Jane Norberg, Chief of the SEC’s Office of the Whistleblower. This is the first time that a whistleblower was awarded a payment with the 120-day reporting provision. Since issuing such awards in 2012, the SEC has doled out roughly $381 million to 62 whistleblowers.

ReadMore: https://www.sec.gov/news/press-release/2019-76

SEC Charges Investment Adviser With Fraud

On May 28, 2019, the SEC charged an investment adviser with overcharging clients by at least $367,000. Investment adviser Stephen Brandon Anderson, owner and operator of now-defunct River Source Wealth Management, LLC, entered agreements to charge customers based on their assets under management, but for two years overcharged his clients by an average of around 40% more than the agreed-upon max customer advisory fee. An SEC order also says that he lied to clients about a longtime asset custodian who ended its relationship with River Source after discovering irregular billing practices, and the SEC says Anderson made “material misstatements” in reports filed with the SEC. Likewise, the SEC found that Anderson failed to implement certain policies. For example, River Source’s policies stated that they daily reconciliations of account positions which did not occur, as well as a review of accounts for suspicious activity. Likewise, the policies and procedures were purchased from a third-party and were never customized or updated to fit the specific risk areas for the firm’s business. Anderson will be prohibited from acting in a supervisory or compliance role, cannot charge fees for at least three years, and agreed to pay more than $500,000 in penalties and disgorgement and prejudgment interest.

SEC Awards $3 Million to Joint Whistleblowers

On June 3, 2019, the SEC said it would pay out $3 million in awards to whistleblowers whose actions led to an SEC investigation and enforcement action involving “an alleged securities law violation that impacted retail investors.” The SEC release also said the whistleblowers took “significant and timely” steps to convince their employer to rectify any fallout from the alleged violations. “Their critical information and assistance helped the SEC bring an important enforcement action aimed at protecting retail investors,” said Jane Norberg, Chief of the SEC’s Office of the Whistleblower.

Read More: https://www.sec.gov/news/press-release/2019-81

SEC Seeks Emergency Relief to Halt Ponzi Scheme Run From College Fraternity House

On June 3, 2019, the SEC made an emergency action to charge a college graduate with running a Ponzi scheme from a fraternity house near the University of Georgia in Athens, Georgia. Syed Arham Arbab, age 22, allegedly orchestrated and operated a scheme in which he offered college students and other young investors the chance to invest in “Artis Proficio Capital,” a hedge fund that the SEC says didn’t actually exist. Arbab claimed the fund returned as much as 56% in the prior year. He also gave assurances of safety, including guaranteeing investor funds up to $15,000 and selling “bond agreements” promising the return of the initial investment and interest. Arbab raised at least $269,000 in these investments, “substantial portions” of which were stored in his own bank and brokerage accounts, then used for “trips to Las Vegas, shopping, travel, and entertainment,” the SEC complaint says.

Read More: https://www.sec.gov/news/press-release/2019-84

Hedge Fund Adviser to Pay $5 Million for Compliance Failures Related to Valuation of Fund Assets

On June 4, 2019, the SEC said a private fund manager agreed to a $5 million penalty, and his chief investment officer agreed to a $250,000 penalty, over their roles in various compliance deficiencies. “An SEC investigation found that Colorado-based investment adviser Deer Park Road Management Company LP (which operates in mortgage-backed securities), in connection with its flagship STS Partners’ fund which has been ranked as one of the most consistent performing hedge funds in the country, failed to have policies and procedures to address the risk that its traders were undervaluing securities and selling for a profit when needed.” The firm failed to protect against the traders providing inaccurate information to pricing vendors and then used these prices to value bonds. The CIO also approved valuations that traders marked up inappropriately, in violation of accounting principles. As a result, certain securities in its flagship fund were inappropriately valued. The committee that was tasked with overseeing valuations was comprised mostly of the principal’s relatives and other unqualified individuals.

Read More: https://www.sec.gov/news/press-release/2019-86

SEC Charges Issuer With Conducting $100 Million Unregistered ICO

On June 4, 2019, the SEC sued Kik Interactive Inc. for illegally selling digital tokens to the tune of $100 million. The SEC’s complaint alleges that Kik’s only product, an online messaging app, lost money for years and that management projected it would run out of money in 2017. In an attempt to pivot the business, Kik raised more than $55 million via the sale of 1 trillion digital tokens, dubbed “Kin.” The SEC also alleges that the Kin tokens were marketed as an investment opportunity – that Kik allegedly said it would build an ecosystem to drive Kin demand and convince other companies to adopt Kin. But the SEC alleges that “these services and systems did not exist and there was nothing to purchase using Kin.”

Read More: https://www.sec.gov/news/press-release/2019-87

SEC Adds Fraud Charges Against Purported Cryptocurrency Company Longfin, CEO and Consultant

On June 5, 2019, the SEC filed an action alleging that Longfin Corp. and its CEO fraudulently conducted an offering of Longfin shares and falsified corporate revenues. Longfin, in an attempt to list on the Nasdaq, allegedly distributed more than 400,000 company shares to insiders and affiliates, without payment, to fraudulently meet Nasdaq listing criteria. Longfin and CEO Venkata Meenavalli then misrepresented how many qualifying shareholders it had, and how many shares were sold in the offering, to the Nasdaq. The SEC also alleges that the company and CEO falsely claimed in SEC filings that the company, which actually operates primarily offshore, was principally managed and operated in the U.S. and it says the company recorded “more than $66 million in sham revenue.” The SEC previously levied charges at the CEO and company – which delisted from the Nasdaq in May 2018 before shutting down in November 2018 – that resulted in a preliminary injunction freezing more than $27 million in allegedly illegal trading proceeds.

The U.S. Attorney’s Office for the District of New Jersey also announced related criminal charges against Meenavalli on June 5.

NFA Orders Houston, Texas Introducing Broker Classic Energy, LLC to Pay a $200,000 Fine and Suspends its President from NFA Membership

On June 6, 2019, the NFA ordered Classic Energy, LLC to pay a $200,000 fine and suspended its president Mathew Webb from membership through January 3, 2020. Webb used his personal company, MDW, to execute block trades. There were 13 block trades that Clean Energy brokered where MDW was on the opposite side of Clean Energy’s customer transaction. At the time that the NFA began its examination, Intercontinental Exchange (ICE) was reviewing the block trades. The NFA contacted ICE to discuss such review. In addition, the firm’s compliance officer was Webb’s wife who was found to have not properly report the firm’s relationship with MDW during the NFA’s pre-exam work and also failed in her supervisory obligations.

KPMG Paying $50 Million Penalty for Illicit Use of PCAOB Data and Cheating on Training Exams

On June 17, 2019, the SEC charged and settled with KPMG LLP for altering past audit work after receiving stolen information about inspections of the firm that would be conducted by the Public Company Accounting Oversight Board (PCAOB). Five, now former, senior officials obtained this information and proceeded to review and revise audit workpapers after the audits had been issued to reduce the likelihood of deficiencies, which they had a high number of in previous inspections. The SEC also alleges that audit professionals cheated on the firm’s internal training exams by sharing answers and manipulating results. Employees who had taken the training would share answers with those who had not, and even manipulated an internal server hosting the trainings to reduce the passing score. KPMG agreed to pay $50 million to settle the charges. In addition, the firm will be forced to undertake a number of corrective actions, including a review and assessment from an independent consultant of the firm’s ethics and integrity controls, as well as its compliance oversight.

SEC Seeks Public Comment on Harmonizing Private Securities Offering Exemptions

On June 18, 2019, the SEC requested public comment on a concept release regarding exempt offering framework. The goal of this is to reduce some of the gaps and inconsistencies in the current framework. Some of the changes that the SEC is proposing would amend the accredited investor definition, Rule 506 of Regulation D, secondary trading of exempt securities, and rules regarding private funds. The concept release is currently in a 90-day comment period. SEC Commissioner Jay Clayton indicated that the SEC is “taking a critical look” into aspects of this regulatory framework.

Wedbush to Pay More Than $8.1 Million for Improper Handling of ADRs

On June 18, 2019, the SEC announced that it had settled with Wedbush Securities, Inc. for $8.1 million regarding the improper handling of “pre-released” American Depositary Receipts (ADRs). The order alleges that Wedbush improperly obtained pre-released ADRs from depositary banks when it should have known that neither the firm nor its customers owned the shares needed to support those ADRs. Acts like this can lead to abusive market practices, such as inappropriate shorts and dividend arbitrage. This action is the 11th against a bank or broker for ADRs, and is a part of a larger, ongoing SEC initiative to investigate these pre-release tactics. So far, it has resulted in monetary settlements exceeding $422 million.

SEC Freezes Assets in International Manipulative Trading Scheme

On June 20, 2019, the SEC announced charges against five foreign traders in China, Singapore, and Malaysia for executing illegal matched trades in Medico International, Inc. (MDDT). The SEC also froze the assets of these individuals including shares of MDDT that could have been wired offshore. The SEC alleges that the traders attempted to manipulate the market of MDDT by matching the order of buys and sells in the security at substantially the same size, prices, and times. These five traders represented about 70% of the trading volume during the time of the trades. In total, the scheme reaped $370,000 in total profit, with hundreds of thousands of trades being held at the time of the asset freeze.

Walmart Charged With FCPA Violations

On June 20, 2019, the SEC charged Walmart with violating the Foreign Corrupt Practices Act (FCPA) for failing to have a sufficient compliance programs for more than a decade as it expanded rapidly on an international level. Walmart agreed to settle $144 million with the SEC and $138 million to the Department of Justice to resolve parallel charges. The charges relate specifically for failures to address or mitigate anti-corruption risk and allowed subsidiaries in Brazil, China, India and Mexico to employ third-party agents who made payments to officials without assurance that they complied with the FCPA. Walmart had planned to put in place training and controls, but placed the plans on hold, which allowed for improper conduct to continue. This was all while there were persistent red flags and corruption allegations, including suggestions from an internal audit of its Chinese and Mexican subsidiaries.

U.K. and EU Regulatory Updates

EU Revised Shareholder Rights Directive (SRD II)

On June 10, 2019, the FCA’s implementation of the revised Shareholder Rights Directive (SRD II) came into force. The main rules that will impact U.K. investment managers are as follows:

To develop and disclose an “engagement policy” in line with COBS 2.2B.6 that sets out how the firm integrates shareholder engagement in its investment strategy;
To publicly disclose on an annual basis how the engagement policy has been implemented, including a general description of voting behaviour and how votes have been cast (COBS 2.2B.7); and
To make additional transparency disclosures on an annual basis to certain institutional investors as per COBS 2.2B.9. Note that the term “institutional investors” has been narrowly defined here to cover only life assurance companies and occupational pension schemes.

The first two requirements above apply on a “comply or explain” basis, with the third requirement being a binding requirement, albeit only when the types of investors mentioned are engaged. Due to the short time period between the publication of the rules and them coming into force, the FCA has stated that firms may comply for an “initial period” by publishing on their website that they are in the process of developing an engagement policy, or that they are considering whether to have one.

EMIR Refit

EMIR Refit is an amending E.U. Regulation effective from June 17, 2019. This amends EMIR, which is the E.U. Regulation dealing with derivatives trading and which requires the reporting of all derivatives transactions along with additional clearing, risk management and margin requirements for OTC derivatives.

The key changes to the scope of EMIR which asset managers should be aware of as a result of EMIR Refit are as follows:

The definition of a financial counterparty (FC) will be expanded, particularly as it relates to funds. In particular, E.U. domiciled AIFs will now be within scope of EMIR, regardless of the location of the AIFM. An indirect consequence of this is that non-E.U. funds managed by non-E.U. managers (e.g. U.S. private funds) will be drawn indirectly within scope of some aspects of EMIR when trading with E.U. counterparties, on the basis that these funds “would be FCs if they were established in the EU.” This will mean that the E.U. counterparties will be required to comply with EMIR bilateral margin requirements in relation to those trades.
A new category of FC will be created, known as Small Financial Counterparties (SFC), who will be exempt from the clearing obligation. The threshold will be based on the aggregate month-end average gross notional value of OTC derivative transactions for the previous 12 months as at the effective date (June 17, 2019). The thresholds are €1 billion for OTC equity and credit derivatives and €3 billion for interest rate, FX, commodity and other OTC derivatives. In practice, some firms may decide to not undertake this calculation and instead to “opt-in” to being an FC, in which case a notification will need to be made to their regulator. Where the thresholds are exceeded then notifications will also be required.
The calculation methodology for the clearing threshold for Non-Financial Counterparties (NFCs) will be simplified, becoming an annual calculation rather than a 30-day rolling average.

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