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District Court finds SEC acted in bad faith and orders it to pay defendant’s attorney fees partially
On March 18, the U.S. District Court in Utah ordered the SEC to pay a defendant’s attorney fees and legal costs partially after the Commission was found to have engaged in “gross abuse” and acted in bad faith on how it presented evidence as part of a temporary restraining order (TRO). Additionally, the court denied the SEC’s motion to dismiss the case without prejudice.
The SEC had filed suit against the defendant, a cryptocurrency company, for allegedly making false and misleading statements to investors, specifically how the company wished to move its assets to the United Arab Emirates in an online video to purportedly “evade law enforcement.” The court had agreed with the SEC and eventually froze the defendant’s assets. In reply, the defendants contended the SEC’s representations were “highly misleading” as they were in response to a viewer’s question posed in a comment as weighing the benefits of operating in the UAE compared to a U.S. regulatory environment. Despite the SEC “affirmatively and repeatedly” asserting that the defendants were moving funds and assets overseas, the court found no evidence to support that claim and had decided to grant the SEC a TRO because of these misrepresentations.
The court emphasized that it does not take its authority to issue TROs lightly, since this authority invokes extreme powers of the federal judiciary. The court now found the SEC made false statements, and despite having multiple opportunities to correct them, proceeded to make additional “layers of false statements” demonstrating “subjective bad faith.”
The court refused to write these issues off as mistakes. In its reply, the SEC stated that its attorneys made inaccurate statements, failed to correct them, and improperly labeled an inference as fact. The court acknowledged that the SEC’s attorneys “fell short” of the responsibility entrusted to it by Congress. On reply, the Commission “deeply regrets” its errors but argued it does not deserve any sanctions since it had not engaged in any “bad faith conduct.” The court disagreed, noting “companies were seized, assets were frozen, and lives were upended.”
Further, the SEC argued that sovereign immunity barred it from any monetary sanctions; the court disagreed. The court admonished the SEC: “[W]hen an attorney makes a false statement of material fact to a court, the lawyer is required to correct it.” The court found the SEC’s explanations unsatisfactory. It also denied the SEC’s motion to dismiss without prejudice. The court sided with the defendants eventually after they asserted the SEC sought to “evade” the court’s oversight. While weighing the decision to impose a greater sanction, the court decided against imposing fees and costs for the entire court case, but directed the Defendants to submit a fee request, if they would like. In all, the court found with “clear evidence” there was a “complete lack of color and an improper purpose on the part of the government.”
SEC to expand “dealer” definition after adoption of two rules
On February 6, the SEC announced its adoption of rules expanding application of the Securities Exchange Act of 1934 (the Exchange Act) to require market participants that “take on significant liquidity-providing roles” to register with the SEC as “dealers” under Sections 15(a) or 15C. In the introduction to the final rule, the SEC explained that “advancements in electronic trading across securities markets” have led to new market participants playing a larger role in market activity that was traditionally supplied by dealers. Additionally, as noted in the SEC’s Fact Sheet, the rules require such market participants to become members of a self-regulatory organization (SRO) and comply with federal laws. The SEC’s rule changes address the phrase “as part of a regular business” in sections 3(a)(5) and 3(a)(44) of the Exchange Act such that market participants that “take on significant liquidity-providing roles” are included in the statutory definition of “dealer” and “government securities dealer.” However, the final rules will exclude any person that has total assets of less than $50 million, or investment companies registered under the Investment Company Act of 1940, central banks, sovereign entities, and international financial institutions. The final rules will go into effect 60 days following Federal Register publication, and the compliance date will be one year after the effective date of the final rules.
SEC, DFPI charge unregistered crypto platform
On February 7, the SEC and DFPI announced charges against a Florida-based crypto platform, for failing to register the offer and sale of a crypto lending product that allowed U.S. investors to deposit or purchase crypto assets into an account in exchange for promised interest payments.
The SEC found that crypto asset accounts with the “interest feature” were offered and sold by the company as securities in the form of investment contracts but failed to register its offer and sale as required by law. Despite voluntarily halting the offering of the interest feature in 2022, the company agreed to pay a $1.5 million penalty to settle the SEC's charges. The SEC also noted that the company announced its intention to terminate all crypto-related products and services in the U.S. on February 22.
In addition, DFPI also entered a consent order with the platform to settle an investigation into the platform’s interest-earning program. The resolution is part of a multistate settlement facilitated by a task force led by California and Washington, comprising of eight state securities regulators. The investigation found that from 2020 through 2022, the platform engaged in the unregistered offer and sale of securities through its crypto interest-earning program. The platform offered the program to investors, allowing them to passively earn interest on crypto assets loaned to the platform. The platform maintained “total discretion” over revenue-generating activities to generate returns for investors, DFPI added. As part of the settlement with DFPI, the company agreed to pay a $1.5 million penalty to the DFPI on behalf of 51 U.S. jurisdictions, mirroring a similar settlement with the SEC for the same amount.
Securities regulators issue guidance and an RFC on AI trading scams
On January 25, FINRA and the CFTC released advisory guidance on artificial intelligence (AI) fraud, with the latter putting out a formal request for comment. FINRA released an advisory titled “Artificial Intelligence (AI) and Investment Fraud” to make investors aware of the growing popularity of scammers committing investment fraud using AI and other emerging technologies, posting the popular scam tactics, and then offering protective steps. The CFTC released a customer advisory called “AI Won’t Turn Trading Bots into Money Machines,” which focused on trading platforms that claim AI-created algorithms can guarantee huge returns.
Specifically in FINRA’s notice, the regulator stated that registration is a good indicator of sound investment advice, and offers the Investor.gov tool as a means to check; however, even registered firms and professionals can offer claims that sound too good to be true, so “be wary.” FINRA also warned about investing in companies involved in AI, often using catchy buzzwords or making claims to “guarantee huge gains.” Some companies may engage in pump-and-dump schemes where promoters “pump” up a stock price by spreading false information, then “dump” their own shares before the stock’s value drops. FINRA’s guidance additionally discussed the use of celebrity endorsements to promote an investment using social media; FINRA states that social media has become “more saturated with financial content than ever before” leading to the rise of “finfluencers.” Finally, FINRA mentioned how AI-enabled technology allows scammers to create “deepfake” videos and audio recordings to spread false information. Scammers have been using AI to impersonate a victim’s family members, a CEO announcing false news to manipulate a stock’s price, or how it can create realistic marketing materials.
The CFTC’s advisory highlighted how scammers use AI to create algorithmic trading platforms using “bots” that automatically buy and sell. In one case cited by the CFTC, a scammer defrauded customers into selling him nearly 30,000 bitcoins, worth over $1.7 billion at the time. The CFTC posted a Request for Comment on the Use of Artificial Intelligence in CFTC-Regulated Markets. The Request listed eight questions addressing current and potential uses of AI by regulated entities, and several more addressing concerns regarding the use of AI in regulated markets and entities for the public to respond to.
SEC rejects petition to amend the “no admit/no deny policy”
On January 30, the SEC rejected a nonprofit’s 2018 rulemaking petition that requested an amendment to Rule 202.5(e) under Commission Rule of Procedure 192(a), which outlines the terms for the Commission's acceptance of settlements in enforcement actions. Specifically, the rule prohibits settlements imposing sanctions if a defendant can publicly deny the Commission's allegations.
The rejection letter emphasizes the SEC’s authority to investigate securities law violations and initiate enforcement actions, saying that considering the request “could undermine confidence in the Commission’s enforcement program.” The SEC highlights its reliance on consent judgments and the contractual nature of settlements, as well as the potential implications of the proposed amendment on the SEC’s settlement process, adding that “it could undermine confidence in the Commission’s enforcement program.” SEC Chair Gary Gensler said in a statement supporting the decision that “a settlement that allows the denial of wrongdoing undermines the value provided by the recitation of the facts, and it muddies the message to the public.”
The Commission has decided not to amend Rule 202.5(e), affirming that the rule is a valid exercise of its authority in pursuing enforcement actions and settling cases. The policy allows the SEC to retain the option of seeking legal remedies if a defendant publicly denies allegations after settling. The letter also emphasizes that the constitutional and statutory arguments presented in the petition lack merit and conflict with established legal precedent regarding the waiver of rights in civil settlements. The Commission underscores the importance of the “no-deny” provision in preserving its ability to challenge public denials in court and rejects the notion that settling defendants can later deny allegations without consequence.
Bank to pay $18 million for violating a whistleblower protection rule
On January 16, the SEC accepted a global financial services firm’s offer of settlement to resolve allegations of violations of the whistleblower protection rule, which prohibits any action that might impede an individual from communicating with the SEC about securities law violations. According to the SEC, from March 2020 through July 2023, the firm asked clients to sign a confidential release if they were issued a credit or settlement from the firm of more than $1,000. The release required clients to “promise[] not to sue or solicit others to institute any action or proceeding against [respondent] arising out of events concerning the [a]ccount.” The SEC claimed that at least 362 clients have signed the release since 2020. In connection with the settlement, the firm agreed to be censured, to cease and desist further violations of the rule, and to pay an $18 million civil money penalty.
FINRA report finds 70 percent of broker-dealer communications potentially violate crypto-asset rule.
On January 23, FINRA published a report which found 70 percent of broker-dealer communications with retail customers showed potential violations of crypto-asset communications as part of a targeted exam. The potential violations fall under FINRA Rule 2210, which require that broker-dealer communications are fair, balanced, based in fact, and do not omit any material facts. With these rules in mind, FINRA reviewed more than 500 retail communications on crypto-assets made by broker-dealers consisting of podcasts, commercials, correspondences, and retail and institutional communications. FINRA’s exam uncovered numerous potential violations of Rule 2210, including the failure to clearly differentiate whether crypto-assets were offered by the member or by a third-party (especially on mobile apps); false statements that crypto-assets function like cash; comparisons of crypto-assets with other assets without providing a comparison of their features and risks; unclear and misleading explanations of how crypto-assets actually work; the failure to include key explanations of how crypto-assets are issued or held; misrepresenting the federal protections that apply to crypto-assets; and making misleading statements. Last, FINRA published a list of questions for broker-dealers to consider when reviewing and supervising their retail communications about crypto-assets.