Exciting Opportunities Ahead
As we begin to wrap up 2021, we are grateful to be gradually moving back into our respective Greyline offices, and we hope our clients are also moving toward a pre-pandemic work environment. Given our giant growth in business over the summer, and new hires from the past year, we are excited to start meeting our team members and clients in person once again.
One of our most exciting recent developments is our acquisition by IQ-EQ, an industry-leading, U.S. and global provider of outsourced business services to the alternative asset industry. Joining forces with IQ-EQ will provide our clients with access to a much broader range of services across the global markets. The culture and philosophy of IQ-EQ aligns closely with ours, and we are confident that this partnership will be a positive one for everyone. Our Managing Partner, Matt Okolita, and Partner, Talia Brant, will be leading our team in this new journey of continued success. You can learn more about this new partnership here.
We are also thrilled to announce the ever-expanding market presence of gVue. gVue is our compliance monitoring software, built from a need to make our clients’ compliance programs more efficient. Years ago, we found that many of our consulting clients were not using technology to collect, organize and review information from employees. We saw room for efficiency. Thus, Greyline developed gVue in-house using our compliance consulting expertise.
As of Q3 2021, gVue has more than 150 client firms. We are extremely proud of our platform’s ease of use and ability to assist our clients in the event of an audit. gVue’s growth should speak for itself, but we are also proud to announce that gVue was awarded the HFM U.S. Services Award 2021 for Best Technology Firm – Newcomer. Thank you to our developers and our gVue team for their work, and to our consultants!
As always, your Greyline team is here to assist you with your compliance monitoring and navigating any of the industry and regulatory updates mentioned in this newsletter. Good luck in Q4!
JP Gonzalez
Partner and CISO, Greyline
Cryptocurrency Highlights
Investment advisers that include digital asset investments in their portfolios face compliance challenges across all aspects of their business, including trading, valuation, anti-money laundering and custody. The Securities and Exchange Commission (“SEC”), according to its most recent Risk Alert on the matter discussed below, defines a “digital asset” as “an asset that is issued and/or transferred using distributed ledger or blockchain technology,” including, without limitation, virtual currencies and tokens. Such digital assets may or may not need to meet the definition of a security under the federal securities laws to be subject to SEC scrutiny.
Our consultants and clients alike are continually monitoring the compliance impacts as the cryptocurrency landscape evolves. While it’s impossible to summarize everything you need to know about cryptocurrency in a single article, some cryptocurrency touchpoints are highlighted below.
“In the regulatory world, it is best to cross the street in the crowd. By partnering with some of the most sought-after digital asset fund managers, we have the experiential knowledge to help educate and advise clients on the evolving best practices and insight from recent interactions with regulators.”
– Darren Mooney, Partner and Co-Head of Business Development
Division of Examinations Risk Alert
In Q1 2021, the SEC’s Division of Examinations issued a Risk Alert providing observations regarding digital assets, including virtual currencies, coins and tokens. The observations were made during examinations of investment advisers managing digital assets that meet the definition of securities (“Digital Asset Securities”). Based on these observations, future examinations will focus on:
- Portfolio management.Whether advisers classify digital assets as Digital Asset Securities, perform due diligence, evaluate and mitigate risks, manage risks associated with “forked” or “airdropped” digital assets and fulfill their fiduciary duties with respect to investment advice.
- Books and records.Whether advisers maintain accurate books and records related to trading activity in digital assets.
- Compliance with the custody rule. This includes reviews for unauthorized transactions, controls around safekeeping of digital assets, business continuity plans (particularly regarding personnel with access to private keys), policies regarding loss of private keys and evaluation of harm, reliability of software used to access digital asset networks, storage of digital assets – both on trading platform accounts and with third-party custodians – and security procedures.
- Adequacy of disclosures. Whether investors provide disclosures regarding the unique and complex risks related to digital assets.
- Pricing client portfolios.Valuation methods for digital assets, as well as how valuation methods are disclosed.
- Registration issues.Matters related to registration, including how RAUM is calculated, how digital assets are characterized, or how funds determine applicable exemptions from registration as investment companies.
The SEC, through this Risk Alert, is encouraging firms to review their policies and procedures, as applicable, and to promote improvements as they relate to the trading and ownership of digital assets.
Digital Assets in Focus: Regulation of Stablecoins
Stablecoins are a type of digital currency that sponsors say marries the stability of national currencies, such as USD, to the ease of trading quickly, found in coins such as Bitcoin. They are supposed to be backed by traditionally safe assets and therefore be redeemed for hard currency on a 1:1 basis. Other cryptocurrencies are not backed by assets and consequently can be extremely volatile. Stablecoins use the same blockchain as other cryptocurrencies and are a quickly growing segment of the approximately $2 trillion digital asset space. Digital assets have been percolating in the minds of regulators for several years now, but in 2021, the focus has sharpened in both scope and concern.
Recently, the Biden administration, SEC and Federal Reserve (“Fed”) have indicated their interest in regulating stablecoins for fear of a “run on the bank” if large numbers of investors seek to redeem at the same time, which happened with some money-market funds during the 2008 financial crisis. That scenario is not limited to the upheaval of the crisis; in 2020, the government’s stabilization efforts also propped up money funds. The fast growth of stablecoins is believed to increase the risk of a run-on-the-bank situation. The administration is contemplating whether stablecoins could be regulated similarly to money market funds, which have limits on the types of assets they can invest in.
The vulnerability of stablecoins lies in the possibility of their sponsors being undercapitalized and/or their reserves fluctuating in value. This instability, commentators say, could be addressed by strict requirements that sponsors invest in true cash equivalents. Unregulated, there is no proactive oversight into what backs the stablecoin and the financial soundness of its sponsor.
A smaller group of bank regulators is set to evaluate whether U.S. banks should be able to hold cryptocurrencies on their balance sheets, and possibly establish a framework for treating their exposures to these instruments.
Case in point, Tether, one of the more well-known stablecoins, was just investigated by the Commodity Futures Trading Commission (“CFTC”) and Office of the Attorney General of the State of New York (“OAG”). The CFTC determined that the company falsely claimed that it had adequate U.S. dollars in reserve to back its tokens, resulting in a $41 million penalty. Specifically, the CFTC found that Tether did not hold its reserves in USD, but instead in unregulated entities and financial products, such as commercial paper and bank repurchase agreements. Tether also allegedly included unsecured receivables in calculating its reserves. Lastly, the CFTC took issue with Tether’s promise that it underwent regular professional audits, stating that “[t]o date, Respondents have not completed an audit of the Tether Reserves.”
In the OAG investigation, Tether paid a $18.5 million penalty over the company’s claim of 1:1 backing with dollars. Tether also agreed to produce reports on its reserves. The OAG found that Tether made numerous false statements to the effect that Tether was backed with dollars and that it used regulated institutions to perform transactions on behalf of its customers.
How does this impact investment advisers? As with all asset classes, firms have a fiduciary duty to ensure that it invests prudently and within clients’ objectives, strategies and limitations. In the case of any new, niche, private or bespoke assets, firms should conduct diligence on prospective investment opportunities to ensure the claims being made are supported and that investing clients in them is suitable.
Cryptocurrency Lending Programs: State Enforcement Actions
At least six states have recently signaled a concern or initiated enforcement actions related to cryptocurrency lending programs, such as BlockFi, signaling a possible SEC interest in doing the same. A summary of state activity is below:
- New York: The Attorney General’s Office ordered two cryptocurrency lending platforms to shut down operations in the state, stating “cryptocurrency platforms must follow the law, just like everyone else, which is why we are now directing two crypto companies to shut down and forcing three more to answer questions immediately.”
- Texas & Alabama: Regulators are concerned that cryptocurrency lending programs are unregistered securities in violation of state securities registration laws.
- New Jersey: The state has expressed similar concerns regarding these platforms, and has ordered the platform BlockFi to stop offering interest-bearing accounts because they are not registered with the state or exempt from registration.
- Kentucky: The state has ordered a cease-and-desist to BlockFi for offering unregistered securities. The state’s department of financial institutions has taken the position that BlockFi Interest Accounts, or BFAs, are unregistered securities, while also emphasizing the risks associated with the lack of SEC registration.
- Vermont: The state issued an order against BlockFi’s high-interest savings accounts for offering unregistered securities.
Experts following these state actions in the past few months have speculated that the SEC is watching closely and likely already in touch with state regulators. It’s possible that SEC action against cryptocurrency lenders is close behind.
Conclusion
Greyline offers compliance support for clients investing in the cryptocurrency and digital asset markets. Important examination areas for clients to be cognizant of include custody, books and records, electronic communications, conflicts of interest, personal trading and valuation. For any questions related to your compliance program, please reach out to your Greyline representative.
Table of Contents
Q3 2021 Regulatory Updates
Table of Contents
Q1 2021 Regulatory Updates
Greyline Employee Spotlight: Melsa McGarey
Greyline Employee Spotlight: Melsa McGareyMelsa McGarey is Director of Technology at Greyline. She joined the team two years ago and splits her time between the Seattle and San Francisco offices.
Q. What is your favorite thing about working for Greyline?
A. As cliché as it is, the people. From the junior team members to the partners, everyone at Greyline is inclusive, hard-working and supportive.
Q. Tell us about one of the most memorable projects you worked on.
A. Working on gVue since its inception has been a true labor of love. From collaborating with various teams internally, to coordinating with service providers and developing new skills, building a product from scratch has been a challenge but incredibly rewarding.
Q. What are your hobbies outside of work?
A. Anything active! Stand-up paddle boarding, hiking and yoga are my go-tos.
Q. Favorite flavor of ice cream?
A. Salted malted chocolate chip cookie dough from Salt & Straw will change your life.
Announcements
In the News: Greyline is the recipient of a 2021 HFM U.S. Services Award in the Best Technology Firm – Newcomer category for gVue.
Website Kudos: We are honored to have our website selected for a 2021 Web Excellence Award in the Financial Services category. We redesigned the site earlier this year with support from our marketing firm, Mischa Communications.
On the Road: Greyline was a Silver Sponsor and exhibitor at the 2021 NSCP National Conference earlier this month
Listen Up: The first episode of Greyline’s new podcast, Between the Lines, is now available!
Regulatory Updates
SECURITIES FRAUD
SEC Charges Hedge Fund Trader in Front-Running Scheme
On July 2, the SEC announced fraud charges against a trader at a major Canada-based asset management firm in connection with a long-running and lucrative front-running scheme.
The SEC says that between January 2015 and at least April 2021, Sean Wygovsky repeatedly traded in his family members’ accounts ahead of large trades executed on the same days in accounts of his employer’s advisory clients. More than 600 times, Wygovsky allegedly bought or sold a stock for one of his relatives’ accounts either right before or during when client accounts were executing large orders for the same stock on the same side of the market. Then, before those accounts had completed their executions, Wygovsky would close the positions in his relatives’ accounts, almost always at a profit.
According to the SEC, this scheme netted more than $3.6 million in illicit gains.
The SEC is seeking disgorgement of ill-gotten gains plus interest, penalties and injunctive relief. Also, the U.S. Attorney’s Office for the Southern District of New York announced criminal charges against Wygovsky in a parallel action.
SEC Obtains Settlement in Fraudulent, Unregistered ICO Case
On July 2, the SEC said it obtained partial consent judgments against three individuals and an entity (Dropil) previously charged with defrauding investors out of more than $1.8 million in a fraudulent and unregistered initial coin offering (ICO).
The SEC says that between January and March 2018, Dropil sold DROP tokens and said that a “trading bot” called Dex would trade various digital assets using the proceed. But instead, Dropil allegedly diverted those funds to other projects, as well as the founders’ personal digital asset and bank accounts.
Other allegations against Dropil include that it gave the false appearance that Dex was operational and profitable; misrepresented the volume and dollar amount of DROP tokens sold during and after the offering; and produced falsified evidence and testimony during an SEC investigation.
Dropil, as well as founders Jeremy McAlpine, Zachary Matar and Patrick O’Hara, have agreed to bifurcated settlements permanently enjoining them from future violations of various federal securities laws, as well as from participating in the offer, purchase or sale of digital securities. The court was to determine disgorgement, prejudgment interest and civil penalty for Dropil, McAlpine and Matar; O’Hara’s settlement was previously approved by a court on June 30, 2020.
McAlpine and Matar also pled guilty to criminal charges in a parallel action brought by the U.S. Attorney’s Office for the Central District of California.
SEC Announces Charges Concerning Space SPAC Merger
On July 13, the SEC announced charges against special-purpose acquisition company Stable Road Acquisition Company, its sponsor SRC-NI, CEO Brian Kabot, proposed merger target Momentus Inc., and Momentus founder and former CEO Mikhail Kokorich, for misleading claims about Momentus’s technology, as well as national security risks surrounding Kokorich.
The SEC says that Kokorich and Momentus, which is an early-stage space transportation, repeatedly told investors it had “successfully tested” its propulsion technology in space. In truth, they had only tested it in space once, and the system failed to achieve its primary mission objectives or demonstrate its commercial viability.
The SEC also says Momentus and Kokorich misrepresented the extent to which national security concerns involving Kokorich undermined Momentus’s ability to secure essential governmental licenses. Moreover, Stable Road repeated Momentus’s misleading statements in public filings, and failed its due diligence obligations to investors – it never reviewed the results of Momentus’s in-space test, nor received documents that would help it assess Kokorich’s national security risks. Also, the SEC says Kabot participated in Stable Road’s inadequate due diligence.
Momentus, Stable Road and Kabot were ordered to pay civil penalties of $7 million, $1 million and $40,000, respectively. Momentus and Stable Road agreed to provide private investment in public equity (PIPE) investors with the right to terminate their subscription agreements prior to the shareholder vote to approve the merger. SRC-NI agreed to forfeit 250,000 founders’ shares it would have received after the businesses combined. And Momentus agreed to undertakings requiring enhancements to its disclosure controls.
Meanwhile, the SEC seeks permanent injunctions, penalties, disgorgement plus prejudgment interest and an officer-and-director bar against Kokorich.
Nikola Founder Charged With Fraud
On July 29, the SEC charged Trevor R. Milton – founder, former CEO and former executive chairman of Nikola Corporation (NASDAQ:NKLA) – for repeatedly disseminating false and misleading information about Nikola’s products and technological accomplishments.
Nikola was founded in 2015 primarily to make trucks running on alternative fuels with low or zero emissions, and to build an alternative fuel station infrastructure to support those vehicles. Since then, Milton had helped Nikola raise more than $1 billion in private offerings and took it public via a SPAC.
The SEC alleges that while Milton encouraged investors to follow him on social media to get fast, accurate information about the company, he used his platform to mislead investors about Nikola’s technological advancements, products, in-house production capabilities and commercial achievements, among other things. The SEC also alleges that Milton reaped tens of millions of dollars in personal benefits because of his misconduct.
The SEC is seeking a permanent injunction, a conduct-based injunction, an officer-and-director bar, disgorgement with prejudgment interest and civil penalties.
SEC Charges Global Crypto Lending Platform, Top Execs, in $2 Bill Fraud
On Sept. 1, the SEC announced it had filed an action against online crypto lending platform BitConnect, its founder Satish Kumbhani, and its top U.S. promoter and his affiliated company, alleging that they defrauded investors out of $2 billion through a global fraudulent and unregistered offering of investments into a program involving digital assets.
The SEC says that between early 2017 and January 2018, the defendants conducted a fraudulent and unregistered offering and sale of securities in the form of a “Lending Program” offered by BitConnect. Allegedly, to induce investors to deposit funds in the program, the defendants falsely represented that BitConnect would deploy its purportedly proprietary “volatility software trading bot to generate exorbitantly high returns. But the SEC alleges that instead of having the bot trade with investor funds, BitConnect and Kumbhani siphoned investors’ funds for their own benefit by transferring those funds to digital wallets controlled by them, their top promoter in the U.S., defendant Glenn Arcaro and others.
The SEC also says BitConnect and Kumbhani established a global network of promoters that were rewarded by commissions, much of which was concealed from investors. Among these promoters was Arcaro, the lead national promoter of BitConnect for the United States. Arcaro allegedly used a website that he created, called Future Money, to lure investors into the Lending Program.
The SEC is seeking injunctive relief, disgorgement plus interest and civil penalties.
App Annie, Founder, Charged With Securities Fraud
On Sept. 14, the SEC announced that App Annie Inc., which provides market data on mobile app performance, as well as co-founder and former CEO Bertrand Schmitt, agreed to settle securities fraud charges for engaging in deceptive practices and making material misrepresentations about how App Annie’s “alternative” data was derived.
The data that App Annie provides includes estimates on how many times a particular company’s app is downloaded, how often it’s used and how much revenue the app generated for the company. This is referred to as “alternative data” because it’s not contained within companies’ financial statements or other traditional data sources.
Companies shared their confidential app performance data with App Annie; in return, App Annie and Schmitt promised not to disclose this data to third parties, assuring them it would be aggregated and anonymized before being used to generate estimates of app performance. Regardless, the SEC found that from late 2014 through mid-2018, App Annie used non-aggregated and non-anonymized data to alter its estimates to make them more valuable to buyers.
App Annie and Schmitt also misrepresented to their trading firm customers that App Annie generated its estimates consistent with the consents it obtained from companies that shared their data, and that App Annie had effective internal controls to prevent the misuse of confidential data. But the SEC says both App Annie and Schmitt knew that trading firm customers were making investment decisions based on App Annie estimates, and the company even shared ideas for how trading firms could use estimates to trade ahead of earnings announcements.
App Annie and Schmitt neither admitted nor denied the findings but consented to the entry of a cease-and-desist order. App Annie will pay a penalty of $10 million, while Schmitt will pay a $300,000 penalty and be prohibited from serving as an officer or director of a public company for three years.
INVESTMENT ADVISER AND BROKER-DEALER COMPLIANCE
Judgments Entered Against Investment Firm, Owner, for Undisclosed Compensation Practices
On July 6, a federal district court entered final judgments against investment adviser Westport Capital Markets, LLC, and its sole owner, Christopher E. McClure, who were found to have defrauded advisory clients and enriched themselves at their clients’ expense.
Between March 2012 and June 2015, Westport Capital and McClure repeatedly purchased securities that generated significant undisclosed compensation for themselves.
Westport Capital and McClure are jointly and severally liable for disgorgement of $632,954, and $187,807 in prejudgment interest, for a total amount of $820,761. Also, Westport must pay a civil penalty of $500,000, and McClure must pay a civil penalty of $200,000.
UBS Settles Charges Related to Volatility-Linked ETP
On July 19, the SEC filed a settled action against UBS Financial Services Inc. for compliance failures relating to sales of a volatility linked exchange-traded product (ETP).
The ETP in question is designed to track short-term volatility expectations in the market as measured against derivatives of a volatility index. The issuer of the product warned UBS that it was not appropriate to hold the product for extended periods; the product’s offering documents backed up that thought, noting that the product likely would decline in value if held over a longer period.
Regardless, while UBS prohibited brokerage representatives from soliciting sales of the product and placed other restrictions on sales of the product to brokerage customers, it did not similarly restrict certain financial advisers from using the product in discretionary managed client accounts. Also, while UBS had established a concentration limit on volatility-linked ETPs, it failed for five years to implement a system for monitoring and enforcing that limit.
Additionally, certain financial advisers were found to have had a flawed understanding of the appropriate use of the ETP and failed to take sufficient steps to understand the risks of holding it for extended periods of time. They then purchased and held the product in client accounts for lengthy periods, including for more than a year in some instances. This led to meaningful losses.
UBS did not admit or deny the SEC’s findings, but agreed to cease and desist from violations of Rule 206(4)-7 of the Investment Advisers Act of 1940, a censure, and disgorgement and prejudgment interest of $112,274. It also agreed to a civil penalty of $8 million, which will be distributed to investors harmed by advisers’ actions concerning the ETP.
Observations from Examinations of Investment Advisers Managing Client Accounts That Participate In Wrap Fee Programs
On July 21, the SEC’s Division of Examinations released a Risk Alert focusing on investment advisers managing client accounts that participate in wrap fee programs.
While these consolidated fees, which include investment advisory services and the execution of transactions, offer clients certainty about costs concerning their investment strategies, they can create conflicts of interest for advisers and risks to investors. The Division focused on wrap fee programs because of the growth of investor assets participating in such programs.
Among some of the staff observations:
- Division staff often observed issues with the examined advisers’ recommendations for clients to participate in wrap fee programs. Advisers sometimes did not monitor trading activity in clients’ accounts (or their monitoring activities were ineffective). Also, advisers sometimes did not have a reasonable basis to believe that the wrap fee programs were in the clients’ best interests.
- The staff also noted that many of the examined advisers had omitted or provided inadequate disclosures, particularly those regarding conflicts of interest, fees and expenses. In some cases, disclosures regarding the same topic were inconsistent in various documents. And in some cases, conflicts of interest were either inadequately described or outright omitted.
- And the staff pointed out weak or ineffective compliance policies and procedures relating to their wrap fee programs. Some advisers omitted compliance policies and procedures; others had both, but they were inadequate. Some advisers inconsistently implemented or enforced (or failed to implement) their policies and procedures, and some advisers did not perform required annual reviews or performed the reviews inadequately.
Those curious about the Division’s other findings can view the full Risk Alert here.
Observations Regarding Fixed Income Principal and Cross Trades by Investment Advisers From an Examination Initiative
On July 21, the SEC Division of Examinations issued a follow-up Risk Alert to provide greater detail on certain compliance issues concerning fixed-income principal and cross trades by investment advisers.
Advisers that enter clients into either principal trades or agency cross trades implicate a variety of legal obligations under the Investment Advisers Act of 1940, particularly its fiduciary duty.
Among some of the staff observations:
- More than half of the deficiencies observed by the staff were related to issues with the examined advisers’ compliance policies and procedures. Some policies and procedures were inconsistent with the advisers’ practices, disclosures and/or regulatory requirements. Some lacked certain considerations or guidance, to the point where advisers’ personnel did not have the full scope of information that might have been necessary to achieve compliance. And some policies and procedures were not effectively tested.
- The staff identified numerous conflicts of interest that were not identified by the advisers and mitigated, disclosed, or otherwise addressed by their compliances.
- More than a third of the cross trade-related deficiencies addressed disclosure issues, such as the omission of certain relevant information concerning cross trading activities in their Form ADVs, or lacking disclosures regarding conflicts of interest associated with executing such trades in their Form ADV Part 2As.
Those curious about the Division’s other findings can view the full Risk Alert here.
SEC Charges 27 Financial Firms for Form CRS Filing, Delivery Failures
On July 26, the SEC announced that 21 investment advisers and six broker-dealers agreed to settle charges over failing to file and deliver client or customer relationship summaries to their retail investors in a timely manner.
The SEC adopted Form CRS on June 5, 2019, and required SEC-registered investment advisers and broker-dealers to file their Forms CRS with the SEC, begin delivering them to prospective and new retail investors by June 30, 2020, and deliver them to existing retail investor clients or customers by July 30, 2020. Firms also had to prominently post their current Form CRS on their website if applicable.
The investment advisers and broker-dealers mentioned above missed those regulatory deadlines, failing to file or deliver Form CRS (or post to its website) until their regulators had reminded them twice of their missed deadlines.
The firms agreed to be censured and to pay civil penalties of varying amounts.
INSIDER TRADING
Three Individuals Charged With Insider Trading
On July 9, the SEC charged three individuals with insider trading ahead of a company’s announcement that it was going to “pivot” from being a beverage business to a blockchain technology firm, causing the company’s stock price to soar.
Eric Watson, an undisclosed control person of Long Blockchain Company (previously Long Island Iced Tea Co.) helped drive this change, and had signed a confidentiality agreement not to disclose the company’s business plans. However, the SEC says Watson nonetheless tipped the plans to his friend and broker, Oliver Barret-Lindsay, who in turn passed the material nonpublic information on to his friend, Gannon Giguiere. Within hours, Giguiere purchased 35,000 shares of Long Blockchain stock.
Shares spiked by more than 380% intraday after the information was released, and Giguiere sold his shares in the run-up, netting more than $160,000 in illicit profits.
The SEC is seeking permanent injunctions and civil penalties for all defendants, as well as an officer-and-director bar for Watson.
SEC Charges Biopharmaceutical Company Employee With Insider Trading
On Aug. 17, the SEC charged a former employee of California-based biopharmaceutical company Medivation Inc. with insider trading ahead of the company’s announcement it would be bought out by pharmaceutical giant Pfizer Inc. (NYSE:PFE).
The SEC says that Matthew Panuwat, then the head of business development for mid-cap oncology-focused firm Medivation, bought short-term, out-of-the-money stock options in Incyte Corporation (NASDAQ:INCY), another mid-cap oncology-focused biopharma company, just days before Pfizer’s Aug. 22, 2016, announcement that it would buy out Medivation at a considerable premium. Panuwat allegedly bought those options within minutes of learning highly confidential information about the merger. He knew that Incyte was considered a comparable company, and anticipated that Medivation’s acquisition would lead to an increase in Incyte’s stock price. Incyte shares jumped by about 8% following the acquisition announcement, and Panuwat allegedly generated illicit profits of $107,066.
The SEC seeks a permanent injunction, civil penalty and an officer-and-director bar.
SEC Charges Netflix Insider Trading Ring
On Aug. 18, the SEC announced insider trading charges against three former Netflix Inc. (NASDAQ:NFLX) software engineers and two close associates who generated more than $3 million in profits by trading on confidential information about the video streaming service’s subscriber growth.
The SEC says that Sung Mo “Jay” Jun was at the center of this long-running scheme to illegally trade on non-public information concerning Netflix’s subscriber growth, which is a key metric the company reported during its quarterly earnings announcements. Sung Mo Jun, who was employed at Netflix in 2016 and 2017, allegedly tipped this information repeatedly to his brother, Joon Mo Joon, and his close friend, Junwoo Chon, who both used it to trade in advance of multiple Netflix earnings announcements.
Even after Sung Mo Jun left Netflix in 2017, he allegedly obtained confidential Netflix info from another insider, Ayden Lee. The SEC says Sung Mo Jun traded, and tipped Joon Jun and Chon, in advance of Netflix earnings announcements between 2017 and 2019. The SEC also says that Sung Mo Jun’s former Netflix colleague Jae Hyeon Bae, another Netflix engineer, tipped Joon Jun about Netflix’s subscriber growth in advance of a July 2019 earnings announcement.
To evade detection, Sung Mo Jun, Joon Jun and Chon allegedly used encrypted messaging applications to discuss their trading.
The SEC Market Abuse Unit’s Analysis and Detection Center uncovered the trading ring by using data analysis tools to identify the traders’ improbably successful trading over time.
Sung Mo Jun, Joon Jun, Chon and Lee have consented to the entry of judgments which, if approved, would permanently enjoin each from violating the charged provisions, with civil penalties (if any) to be decided later by the court. Sung Mo Jun also is barred from being an officer or a director. And Bae faces a civil penalty of $72,875.
SEC Charges Investment Bank Compliance Analyst With Insider Trading in Parents’ Accounts and Obtains Asset Freeze
On Sept. 29, the SEC charged Spanish national Jose Luis Casero Sanchez, a former senior compliance analyst who worked in the Warsaw, Poland, office of an international investment bank, with insider trading. It also announced it had obtained an emergency court order to freeze Sanchez’s assets, including certain accounts he used for his alleged scheme.
The SEC says that Sanchez enjoyed broad access to highly sensitive information regarding mergers and other transactions in which his firm was involved. He had that information so he could help the firm ensure that employees kept that information confidential and did not engage in insider trading. But between September 2020 and May 2021, Sanchez allegedly abused his position by trading on at least 45 events involving the bank’s clients based on material, nonpublic information.
According to the SEC’s complaint, Sanchez avoided detection by placing mostly small trades – generating modest profits of more than $471,000 in ill-gotten gains – and traded in multiple U.S.-based brokerage accounts held in the name of one of his parents.
The SEC is seeking a permanent injunction, disgorgement, prejudgment interest and a civil penalty. Sanchez’s parents – Jose Luis Casero Abellan and Maria Isabel Sanchez Gonzalez – were also charged as relief defendants.
Digital Assets
Poloniex Charged for Operating Unregistered Digital Asset Exchange
On Aug. 9, the SEC announced that Poloniex LLC settled charges for operating an unregistered online digital asset exchange in connection with its operation of a trading platform that facilitated the buying and selling of digital asset securities.
The SEC says that between July 2017 and November 2019, when Poloniex sold its platform, that the company operated a web-based trading platform that facilitated the buying and selling of digital assets, including those that were investment contracts (and therefore securities).
An SEC order also says Poloniex’s trading platform met the criteria of an “exchange” because it provided the non-discretionary means for trade orders to interact and execute through the combined use of the Poloniex website, an order book and the Poloniex trading engine. However, Poloniex did not register as a national securities exchange nor did it operate pursuant to an exemption from registration at any time.
And in August 2017, Poloniex employees allegedly said internally that they wanted Poloniex to be “aggressive” in making new digital assets available for trading on Poloniex’s platform, including some that might be considered securities under the Howey test. The SEC also says that in or around July 2018, Poloniex determined it would keep providing users of its platform the ability to trade digital assets it believed were at “medium risk” of being considered securities because of the business rewards the company would reap.
Poloniex did not admit nor deny the SEC’s findings but agreed to a cease-and-desist order, and to pay disgorgement of $8,484,313, prejudgment interest of $403,995 and a civil penalty of $1.5 million, for a total of more than $10 million.
SEC Requests Information and Comment on Broker-Dealer and Investment Adviser Digital Engagement Practices
On Aug. 27, the SEC announced that it is requesting information and public comment on matters related to the use of digital engagement practices by broker-dealers and investment advisers.
Among the tools in question: behavioral prompts, differential marketing, game-like features (“gamification”) and other design elements or features designed to engage with retail investors on digital platforms such as websites and applications, as well as the analytical and technological tools and methods (collectively called digital engagement practices, or “DEPs”).
The SEC is trying to gain a better understanding of market practices associated with firms’ use of DEPs and the related analytical and technological tools and methods. It also wants to learn what conflicts of interest might arise from optimization practices, and whether those practices affect the determination of whether DEPs are making a recommendation or providing investment advice.
The public comment period remained open for 30 days following publication of the Request in the Federal Register.
Three Media Companies Charged With Illegal Offerings of Stock and Digital Assets
On Sept. 13, the SEC charged New York City-based GTV Media Group Inc. and Saraca Media Group Inc., as well as Phoenix-based Voice of Guo Media Inc., with conducting an illegal unregistered offering of GTV common stock. The SEC also charged GTV and Saraca for conducting an illegal unregistered offering of a digital asset security referred to as both G-Coins and G-Dollars.
The SEC says that between April and June 2020, the respondents solicited thousands of individuals to invest in the GTV stock offering, while GTV and Saraca solicited individual to invest in G-Coins. The respondents disseminated info about the offerings through publicly available videos on GTV’s and Saraca’s websites, as well as social media.
The respondents raised roughly $487 million from more than 5,000 investors between the two offerings. However, no registration statements were filed or in effect for either offering, and the respondents’ offers and sales did not qualify for an exemption from registration.
GTV and Saraca neither admitted nor denied the SEC’s findings but agreed to a cease-and-desist order, to pay disgorgement of more than $434 million plus prejudgment interest of about $16 million on a joint and several basis, and to each pay a civil penalty of $15 million. Voice of Guo, meanwhile, agreed to a cease-and-desist order, to pay disgorgement of more than $52 million plus prejudgment interest of nearly $2 million, and to pay a civil penalty of $5 million.
CYBERSECURITY
Pearson Charged for Misleading Investors About Cyber Breach
On Aug. 16, the SEC announced that London-based educational publisher and service provider Pearson (NYSE:PSO) agreed to pay $1 million to settle chargers that it misled investors about a 2018 cyber intrusion and had inadequate disclosure controls and procedures.
The SEC says that Pearson made misleading statements and omissions about the data breach, in which student data and administrator log-in credentials of roughly 13,000 school, district and university customer accounts were stolen. Pearson’s semi-annual report, filed in July 2019, listed a data privacy incident as a hypothetical risk, when in reality, the 2018 cyber breach had already occurred. Moreover, in a July 2019 media statement, Pearson said the breach may include dates of births and email addresses, but it actually knew such records were stolen. It also said it had “strict protections” in place, but it had failed to patch the vulnerability for six months after it was notified.
The SEC’s order also says that Pearson’s disclosure controls and procedures were not designed to ensure that those responsible for making disclosure determinations were informed of certain information about the circumstances surrounding the breach.
Pearson neither admitted nor denied the SEC’s findings but agreed to cease and desist from committing violations of the charged provisions and to pay a $1 million civil penalty.
SEC Announces Three Actions Charging Deficient Cybersecurity Procedures
On Aug. 30, the SEC sanctioned eight firms in three actions for failures in their cybersecurity policies and procedures that resulted in email account takeovers exposing the personal information of thousands of customers and clients at each firm.
Those firms are Cetera Advisor Networks LLC, Cetera Investment Services LLC, Cetera Financial Specialists LLC, Cetera Advisors LLC and Cetera Investment Advisers LLC (collectively, the Cetera Entities); Cambridge Investment Research Inc. and Cambridge Investment Research Advisors Inc. (collectively, Cambridge); and KMS Financial Services Inc. (KMS).
The SEC says that between November 2017 and June 2020, unauthorized third parties took over the cloud-based email accounts of more than 60 Cetera Entities personnel, resulting in the exposure of personally identifying information (PII) of at least 4,388 customers and clients. Cetera Advisors LLC and Cetera Investment Advisers LLC were also found to have sent breach notifications to clients that included misleading language suggesting that the notifications were issued much sooner than they were following the discovery of the incidents.
The SEC also says that between January 2018 and July 2021, unauthorized third parties took over the email accounts of more than 121 Cambridge representatives, resulting in 2,177 Cambridge customers and clients having their PII exposed. An SEC order also says Cambridge discovered the first email takeover in January 2018 but failed to adopt and implement firm-wide enhanced security measures until 2021, resulting in additional real and potential exposure of customer and client records and information.
And the SEC says that between September 2018 and December 2019, unauthorized third parties took over email accounts of 15 KMS financial advisers or their assistants, resulting in the PII exposure of about 4,900 KMS customers and clients. KMS also failed to adopt written policies and procedures requiring additional firm-wide security measures until May 2020, then did not fully implement those measures until August 2020, exposing customers and clients to additional risk.
None of the above firms admitted nor denied the SEC’s findings but agreed to cease and desist from future violations, to be censured and to pay penalties. The Cetera Entities will pay a $300,000 penalty, Cambridge will pay a $250,000 penalty, and KMS will pay a $200,000 penalty.
FOREIGN CORRUPT PRACTICES ACT
SEC Charges World’s Largest Advertising Group With FCPA Violations
On Sept. 29, the SEC proposed amendments to Form N-PX to enhance the information that mutual funds, exchange-traded funds (ETFs) and certain other funds report about their proxy votes.
The amendments would require funds to tie the description of each voting matter to the issuer’s form of proxy and to categorize each matter by type to help investors identify votes of interest and compare voting records. It also would prescribe how funds organize their reports and require them to use a structured data language to make the filings easier to analyze. Additionally, funds would be required to disclose how their securities lending impacted their voting.
Institutional investment managers also would be required to disclose how they voted on executive compensation (“say-on-pay”) matters.
The proposal was published on SEC.gov and in the Federal Register. The public comment period will remain open for 60 days after publication in the federal register.
