Greyline Insights – Q1 2019 « Greyline Partners, LLC

Greyline Insights – Q1 2019

In this Issue

In this inaugural edition of Greyline Insights, we explore a number of recent regulatory developments that occurred during Q4 2018 and Q1 2019.

Despite the government’s month-long hiatus earlier this year, there was still plenty of regulatory activity to cover, including the SEC’s 2019 Examination Priorities, a new risk alert, several enforcement actions, and a few new pieces of key regulatory guidance.

Going forward, Greyline Insights will be published on a quarterly basis, so please keep an eye out for subsequent editions. While this one is largely focused on U.S. matters, in the future we will offer a more global perspective with the assistance of our newest partner, Nick Thomas, who is spearheading our U.K. and European initiatives from our London office.

Sean Wilke
Partner, Greyline

The SEC’s 2019 Exam Priorities

The SEC’s Office of Compliance Inspections and Examinations (OCIE) has released its examination priorities for 2019, and this year’s focuses include digital assets, cybersecurity and matters of importance to retail investors, such as fees, expenses, and conflicts of interest.

“OCIE continues to thoughtfully approach its examination program, leveraging technology and the SEC staff’s industry expertise,” SEC Chairman Jay Clayton said. “As these examination priorities show, OCIE will maintain its focus on critical market infrastructure and Main Street investors in 2019.”

This year’s examination priorities are broken down into the following categories:

Compliance and Risks in Critical Market Infrastructure: OCIE will continue to examine firms that provide services critical to the proper function of capital markets – including clearing agencies, national securities exchanges, and transfer agents – and focus on their operations and compliance.
Retail Investors, Including Seniors and Those Saving for Retirement: Protecting Main Street investors is once again a priority for 2019. OCIE will focus examinations on the disclosure and calculation of fees, expenses, and other charges investors pay, the supervision of representatives selling products and services to investors, broker-dealers entrusted with customer assets, and portfolio management and trading.
FINRA and MSRB: OCIE will continue its oversight of FINRA by focusing examinations on FINRA’s operations and regulatory programs, and the quality of FINRA’s examinations of broker-dealers and municipal advisers. OCIE will also examine MSRB to evaluate the effectiveness of select operations and internal policies, procedures, and controls.
Cybersecurity: There will be a lot of emphasis on cybersecurity for each of OCIE’s examination programs, with particular concentration on proper configuration of network storage devices, information security governance, and policies and procedures related to retail trading information security.
Anti-Money Laundering Programs: Exams will assess compliance with applicable anti-money laundering requirements, including whether broker-dealers are appropriately adapting their AML programs to address their regulatory obligations.

While these priorities are the main areas of focus this year, they will not be the only issues OCIE addresses in its exams, risk alerts, and investor and industry outreach.

Regulatory Updates

SEC Charges ICO Superstore and Owners With Operating as Unregistered Broker-Dealers

On Sept. 11, 2018, the SEC announced that TokenLot LLC – an initial coin offering (ICO) “Superstore” – and its owners would settle charges of acting as unregistered broker-dealers. This was the first case in which the SEC charged an unregistered broker-dealer for selling digital tokens since it issued the DAO Report in July 2017.

Elad Roisman Sworn In as SEC Commissioner

On Sept. 11, 2018, Elad Roisman was sworn in as SEC Commissioner by SEC Chairman Jay Clayton. Roisman came to the SEC from the Senate Banking Committee, where he was Chief Counsel. He was nominated by President Donald Trump, and his nomination was confirmed on Sept. 5.

SEC Uses Data Analysis to Detect Cherry-Picking by Broker

On Sept. 12, 2018, the SEC charged a broker from New Jersey with misusing access to customers’ brokerage accounts to benefit himself and his family. Michael Bressman faces fraud charges in federal district court after he obtained at least $700,000 in illicit trading profits over a six-year period. The alleged fraud was discovered through data analysis used to identify suspicious trading patterns.

SEC Shuts Down $345 Million Fraud and Obtains Asset Freeze

On Sept. 19, 2018, the SEC announced that it obtained a court order to halt an ongoing Ponzi-like scheme that raised more than $345 million from more than 230 U.S. investors. The SEC complaint alleges that Kevin Merrill, Jay Ledford and Cameron Jezierski lured investors into their scheme by promising substantial profits from the purchase and resale of consumer debt portfolios. However, the trio actually used the funds to make Ponzi-like payments to early investors instead of directing investor funds to the acquisition and servicing of debt portfolios.

SEC Charges Firm With Deficient Cybersecurity Procedures

On Sept. 26, 2018, the SEC announced that Voya Financial Advisors Inc. (VFA), a Des Moines-based broker-dealer and investment adviser, would pay $1 million to settle charges following a cyber intrusion that compromised its customers’ personal information. VFA was charged with violating the Safeguards Rule and the Identity Theft Red Flags Rule, which protect confidential customer information and safeguard customers from the risk of identity theft. This was the first SEC enforcement action for violations of the Identity Theft Red Flags Rule.

SEC Suspends Trading in Company for False Cryptocurrency Claims About SEC Regulation and Registration

On Oct. 22, 2018, the SEC suspended trading in the securities of Nevada-based American Retail Group, Inc. (OTC:ARGB), also known as Simex, Inc., after it issued statements about partnering with a supposed SEC-qualified custodian. The SEC’s trading suspension order states that American Retail Group issued two press releases in August 2018 claiming the company had partnered with an SEC-qualified custodian for use with cryptocurrency transactions that would be “under SEC Regulations.” The releases also said the company was conducting a token offering that was “officially registered in accordance [with] SEC requirements.” However, the SEC does not endorse or qualify custodians for cryptocurrency.

SEC Updates List of Firms Using Inaccurate Information to Solicit Investors

On Oct. 31, 2018, the SEC released its updated Public Alert: Unregistered Soliciting Entities (PAUSE) list of unregistered entities that use misleading information to solicit primarily non-U.S. investors. New additions to the list include 16 soliciting entities, four impersonators of genuine firms, and eight bogus regulators. Each of these firms provided inaccurate information about their affiliation, location, or registration. The SEC also made technical updates to its database – including consolidating the active and achieved lists – so it’s easier for retail investors to search and obtain information about unregistered entities.

SEC Enforcement Division Issues Report on FY 2018 Results

On Nov. 2, 2018, the SEC’s Enforcement Division issued its annual report on its efforts to protect investors and market integrity. The report presents the activities of the division from qualitative and quantitative perspectives, and it highlights several significant actions and initiatives from 2018.

SEC Charges Family Friend of Former Investment Banker With Insider Trading

On Nov. 2, 2018, the SEC charged Hamed Ettu, an IT professional in Texas, with fraud, alleging that he participated in an insider trading scheme perpetrated by Damilare Sonoiki, a former Wall Street investment banking analyst. The complaint alleges that Ettu, a family friend of Sonoiki, received illegal tips about nonpublic impending mergers via text messages. Ettu and Sonoiki then used the information to, via Ettu’s brokerage account, purchase the call options of companies that were about to be acquired. The pair made approximately $93,000 in illegal profits by selling the positions after the deals were announced.

Stock Research Firm and Co-Founders Charged With Deceiving Inventors in Supposedly Unbiased Reports

On Nov. 8, 2018, the SEC charged SeeThruEquity LLC, a stock research firm and its co-founders, brothers Ajay and Amit Tandon, with defrauding investors by issuing reports purportedly based on “unbiased” and “not paid for” research – when they actually received thousands of dollars from the report issuers. SeeThruEquity and the Tandon brothers camouflaged the payments by inviting companies to make a “presentation” at an investor conference to receive a research report for free. They allegedly collected up to several thousand dollars in conference presentation fees per company. The SEC alleges that the brothers often instructed SeeThruEquity analysts to use different, higher price targets for covered issuers than those yielded through purported quantitative analysis.

Two ICO Issuers Settle SEC Registration Charges, Agree to Register Tokens as Securities

On Nov. 16, 2018, the SEC announced that it settled charges against CarrierEQ Inc. (Airfox) and Paragon Coin Inc. for selling digital tokens in initial coin offerings (ICOs) without proper registration. These were the SEC’s first imposed civil penalties solely for ICO securities offering registration violations. Both companies have agreed to return funds to harmed investors, register the tokens as securities, file periodic reports with the commission, and pay penalties.

Two Celebrities Charged with Unlawfully Touting Coin Offerings

On Nov. 29, 2018, the SEC announced that it settled charges against professional boxer Floyd Mayweather Jr. and music producer Khaled Khaled, known as DJ Khaled, for failing to disclose payments they received for promoting investments in initial coin offerings. The SEC found that Mayweather failed to disclose promotional payments from three ICO issuers, including $100,000 from Centra Tech Inc., and Khaled failed to disclose a $50,000 payment from Centra Tech. Both Mayweather and Khaled promoted the ICOs via their social media accounts. Their promotions came after the SEC issued its DAO Report in 2017 warning that coins sold in ICOs may be securities, and that those who offer and sell securities in the U.S. must comply with federal securities laws. These were the SEC’s first cases to charge touting violations involving ICOs.

SEC Adopts FAIR Act Rules Promoting Research Reports on Investment Funds

On Nov. 30, 2018, the SEC adopted rules and amendments to improve research on mutual funds, exchange‑traded funds, registered closed-end funds, business development companies, and similar covered investment funds. The changes will allow for better research on investment funds by harmonizing the treatment of such research with research on other public companies. The SEC took this action in furtherance of the mandate in the Fair Access to Investment Research Act of 2017 (FAIR Act).

SEC Halts Alleged Insider Trading Ring Spanning Three Countries

On Dec. 6, 2018, the SEC filed insider trading charges against Rajeshwar Gannamaneni, an IT contractor, as well as his wife, Deepthi Gandra, and his father, Linga Rao Gannamaneni. The SEC obtained a court-ordered freeze of assets in three U.S. brokerage accounts and one U.S. bank account connected to the alleged trading. The SEC’s complaint alleges that Gannamaneni provided nonpublic information about impending mergers, acquisitions, and tender offers to his wife and father. According to the complaint, the three collectively reaped approximately $600,000 in profits by trading while in possession of inside information.

SEC Charges the Hain Celestial Group With Internal Controls Failure

On Dec. 11, 2018, the SEC announced settled charges against The Hain Celestial Group, Inc. (NASDAQ:HAIN), a company specializing in natural and organic foods, stemming from weaknesses in the company’s internal controls related to end-of-quarter sales practices. Between 2014 and 2016, sales personnel for Hain offered incentives to the company’s two largest distributors at the end of fiscal quarters to encourage them to buy sufficient inventory for Hain to meet quarterly internal sales targets. The incentives Hain offered included the right to return for products that spoiled or expired before they were sold, as well as cash incentives of up to $500,000, substantial discounts, and extended payment terms. Given the company’s extensive cooperation with the SEC’s investigation, including self-reporting and remediation efforts, the SEC did not impose a monetary penalty on the company. Hain has since made organizational changes, including the retention of staff in compliance positions, and has implemented changes to its revenue recognition practices.

SEC Issues Risk Alert on Advisers Personnel’s Use of Electronic Messaging

On Dec. 14, 2018, the SEC’s Office of Compliance Inspections and Examinations (OCIE) issued a Risk Alert to remind advisers of their obligations when their personnel use electronic messaging – such as social media, text messages, email and instant messaging – and to help advisers improve their compliance programs to adhere to applicable regulatory requirements. OCIE’s examination focused on whether and to what extent advisers complied with specific rules – including Rule 204-2 (“Books and Records Rule”) and Rule 204-2(a)(11) (“Advertisements Recordkeeping Rule”) – and determined whether advisers adopted and implemented polices to comply with both of these rules. The alert also included a list of best practices for complying with the Books and Records Rule and the Advertisements Recordkeeping Rule

SEC Issues Custody Rule No-Action Letter Regarding Adviser’s Administrative Services Loan Syndication Business

On Dec. 20, 2018, the SEC granted conditional no-action relief to Madison Capital Funding LLC for administrative agents under syndicated loans that also act as investment advisers for pooled investment vehicles, or separately managed accounts that are also part of the lending syndicate. Specifically, this letter granted relief from the requirements of the Custody Rule if Madison satisfied several conditions, including, amongst other things, establishing an agency account maintained at a qualified custodian, which will hold only the assets of the syndicate participants and the corresponding loan, developing and implementing controls for administrative agency services, and obtaining an internal control report at least annually prepared by an qualifying independent public accountant. The SEC also affirmed it was “willing to entertain other no-action request where investment advisers serving as administrative agents have similarly taken or propose to take steps to minimize that risk that client funds or securities could be lost or withdrawn or misappropriated by the investment adviser.”

2019 Brings New Requirements for NFA Member Asset Managers

The National Futures Associations (NFA) issued new requirements for asset managers who are NFA members, including updating its Interpretive Notice 9070, NFA Compliance Rules 2-9, 2-36 and 2-49: Information Systems Security Programs (Cybersecurity Notice) and the Interpretive Notice, NFA Compliance Rule 2-9: CPO Internal Controls System (Internal Controls Notice) The Cybersecurity Notice will be effective on April 1 and the Internal Controls Notice is expected to take effect on or shortly after April 1.

SEC Will Recommend Offering Reforms for Business Development Companies and Registered Closed-End Funds

The SEC will propose rule amendments to implement provisions of the Small Business Credit Availability Act and the Economic Growth, Regulatory Relief, and Consumer Protection Act. The proposed amendments will modify the registration, communications, and offering processes to improve access to capital, and facilitate investor communications by business development companies and registered closed-end funds.

Registered Investment Adviser and Former COO Charged With Defrauding Client

On March 15, Talimco LLC, a registered investment adviser, and Grant Gardner Rogers, the former chief operating officer of the firm, have been charged with manipulating the auction of a commercial real estate asset on behalf of one client for the benefit of another. According to the SEC, “In or about April 2015 while selling a commercial real estate asset on behalf of a collateralized debt obligation client, Talimco and Rogers were aiming to acquire the asset for another client, a private fund. Talimco and Rogers owed its selling client a fiduciary duty, which included an obligation to take steps to use its best efforts to maximize the price obtained for the asset by identifying willing bidders.” But rather than identifying legitimate bidders, Rogers used the firm’s affiliated private fund client to make a bid, as well as two unwilling bidders. As a result, Talimco’s private fund client was the highest bidder and acquired the asset, and went on to sell it for a substantial profit.

Mobile TeleSystems Pays $100 Million to Resolve FCPA Violations

On March 6, the SEC announced that Mobile TeleSystems PJSC (MTS) (NYSE:MBT), a Russian telecommunications company, will pay $100 million to resolve SEC charges of violating the Foreign Corrupt Practices Act (FCPA) to win business in Uzbekistan. According to the SEC, “MTS bribed an Uzbek official who was related to the former President of Uzbekistan and had influence over the Uzbek telecommunications regulatory authority. During the course of the scheme, MTS made at least $420 million in illicit payments for the purpose of obtaining and retaining business. The payments enabled MTS to enter the telecommunications market in Uzbekistan and operate there for eight years, during which it generated more than $2.4 billion in revenues.”

Gladius Network LLC Settles Unregistered ICO Charges

On Feb. 20, Gladius Network LLC, a Washington, D.C.-based company, was charged with conducting an unregistered initial coin offering (ICO), which it self-reported to the SEC. The ICO was conducted in late 2017, after the SEC warned that ICOs can be securities offerings, and raised approximately $12.7 million in digital assets. According to the SEC, “Gladius did not register its ICO under the federal securities laws, and the ICO did not qualify for an exemption from registration requirements. Gladius self-reported to the SEC’s Enforcement staff in the summer of 2018, expressed an interest in taking prompt remedial steps, and cooperated with the investigation.”

Expansion of “Test-the-Waters” Modernization Reform on the Horizon

The SEC will propose an expansion of modernization reform that will allow investors’ views about potential offerings to be considered earlier in the process. The new rule and amendments will “expand the ‘test-the-waters’ accommodation—currently available to emerging growth companies or ‘EGCs’—to all issuers, including investment company issuers,” according to the SEC. The proposal would permit all prospective issuers – not just EGCs – to evaluate market interest in a possible IPO or other proposed registered securities offering by allowing discussions with specific investors before the filing.

Former Apple Senior Attorney Charged With Insider Trading

On Feb. 13, Gene Daniel Levoff, Apple’s former global head of corporate law and corporate secretary, was charged with insider training. The SEC alleges that Levoff obtained confidential information about Apple’s quarterly earnings announcements while on a committee of senior executives who reviewed the company’s draft earnings materials prior to their publication. According to the SEC, “Levoff traded Apple securities ahead of three quarterly earnings announcements in 2015 and 2016 and made approximately $382,000 in combined profits and losses avoided.”

Revised Advertising Rules May Be Released in April

The SEC will likely be announcing reforms to rules regarding advertising in the next few weeks. As indicated in prior regulatory pronouncements, the SEC is targeting April for the release. The SEC has issued no-action letters and risk alerts regarding advertising, however, the advertising rules haven’t been revised since they took effect in the 1960s. Investment advisers are hoping the new rules address the use of social media and endorsements.

Greyline Insights Q1 2022

The Next Chapter The first quarter of 2022 was eventful, to say the least. With the uptick in COVID-19 cases early in the quarter, we were sent back to our

SEC Proposes Rules on Special Purpose Acquisition Companies, Shell Companies and Projections

On March 30, 2022, the U.S. Securities and Exchange Commission (“SEC”) proposed rules under the Securities Act of 1933 and Securities Exchange Act of 1934 to codify enhancements of disclosure