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SEC alleges whistleblower protection violations in customer gag clauses
On September 4, the SEC announced it had settled charges against three affiliated registrants (the respondents) accused of violating the whistleblower protection rule. According to the SEC order, from May 2021 through February 2024, the respondents required collectively eleven retail clients to sign confidentiality agreements that hindered them from reporting potential securities law violations to the SEC. Specifically, some agreements included provisions that restricted clients from disclosing information unless an inquiry was initiated by a regulator and required clients to represent that they had not reported and would not report the underlying dispute to any securities regulator.
The SEC found that respondents willfully violated Rule 21F-17(a) under the Securities Exchange Act, which prohibits taking any action to impede an individual from communicating with the SEC about possible securities law violations. The respondents agreed to the settlement without admitting or denying the findings.
Respondents are ordered to cease and desist from future violations of the whistleblower protection rule and are required to pay civil monetary penalties: the Commission-registered investment adviser will pay $160,000, the Commission-registered broker-dealer will pay $70,000, and the state-registered investment adviser will pay $10,000. The SEC noted that it considered the respondents’ cooperation and remedial efforts in determining the penalties and that penalties were apportioned based on the relative size and financial condition of the entities involved.
SEC charges company for defrauding customers for $6M via false IPO
On August 26, the SEC filed a complaint and demand for a jury trial against a South Dakota corporation, its China-based investment adviser, and their CEO for allegedly defrauding investors out of millions of dollars in violation of several securities laws. The SEC alleges the defendants made false statements about guaranteed returns, the safety of client investments, the investment adviser’s business relationships, and the status of an IPO — which never occurred. According to the complaint, the defendants stopped communicating with investors and the website used to access funds was taken down.
The SEC seeks several forms of relief in its complaint, including a permanent injunction preventing the defendants from continuing their alleged fraudulent activities, disgorgement of funds, and civil penalties. Additionally, the SEC requested that the CEO be barred from serving as an officer or director of a public company.
District Court dismisses FINRA challenge for lack of subject matter jurisdiction
On September 4, the U.S. District Court for the Eastern District of Pennsylvania dismissed a plaintiff’s attempt to enjoin FINRA from proceeding with a disciplinary hearing against the plaintiff. The plaintiff’s disciplinary issues stemmed from a complaint filed against him in December 2023, alleging violations of FINRA rules during his employment at a financial group. As previously covered by InfoBytes, the plaintiff had asked the court for a temporary restraining order and a preliminary injunction to enjoin FINRA from proceeding with the hearing. The plaintiff argued that FINRA’s proceedings violated his Seventh Amendment right to a jury trial, referencing the U.S. Supreme Court’s decision in SEC v. Jarkesy, which held that a respondent to an enforcement action requires a jury trial for civil penalties. However, the district court held that the plaintiff’s claims must appeal to FINRA’s Office of Hearing Officers (OHO) or to an appellate court.
FINRA argued that under the standard set forth in Thunder Basin Coal Co. v. Reich, a 1994 U.S. Supreme Court decision, the court lacked subject matter jurisdiction. The court agreed, holding that: (i) denial of the district court’s jurisdiction would not foreclose meaningful judicial review; (ii) the claim is not wholly collateral to the Securities Exchange Act’s review; and (iii) the claim is within the SEC’s expertise. The plaintiff’s case will now proceed through the administrative channels like the OHO, with the potential for further appeals.
Broker-Dealer fined for “No Remuneration” indicators in FINRA reports
On August 27, FINRA accepted a broker dealer firm’s Letter of Acceptance, Waiver, and Consent (AWC) regarding alleged trade reporting violations and supervisory failures. According to the AWC, the respondent failed to include a required “No Remuneration” indicator on about 50,000 reports to FINRA’s Trade Reporting and Compliance Engine (TRACE) from 2016-2023, which violated FINRA Rules 6730 and 2010. FINRA further alleged that the respondent did not establish an acceptable system to achieve compliance with Rule 6730 and did not conduct supervisory reviews of TRACE reports, thereby failing to detect errors with certain indicators.
Without admitting or denying the allegations, the respondent agreed to a censure, a $175,000 fine, and an undertaking to certify within 60 days that the firm remediated the alleged issues and implemented a supervisory system designed to comply with FINRA Rule 6730.
Crowdfunding portal member expelled from FINRA Membership
On August 26, FINRA accepted a Letter of Acceptance, Waiver, and Consent (AWC) from a former funding portal member (the respondent) that acted as an intermediary for crowdfunding offerings conducted under Section 4(a)(6) of the Securities Act. The AWC outlined the respondent’s alleged violation of FINRA Funding Portal Rules 800(a) and 200(a) and FINRA Rule 8210. It asserted that FINRA began investigating one of the respondent’s offerings in January 2023 and, while the respondent initially cooperated with the investigation, the respondent subsequently “fail[ed] to respond to requests for documents and information,” despite multiple requests.
To resolve FINRA’s allegations, the respondent consented to an expulsion from FINRA funding portal membership, effective upon approval of the AWC, and acknowledged that the AWC will become part of its permanent disciplinary record. Respondent did not admit nor deny FINRA’s claims.
Broker-dealer to pay $1.19M for suspicious activity reporting violations
On August 12, the SEC issued published a settled enforcement action order against a broker-dealer for failing to monitor, investigate, and file Suspicious Activity Reports (SARs) between March 2020 and May 2023, violating Sections 15(b) and 21C of the Securities Exchange Act. The SEC ordered the broker-dealer to cease and desist from future violations of Section 17(a) of the Exchange Act and Rule 17a-8. The firm was also censured and required to pay a civil money penalty of $1.19 million.
The broker-dealer admitted other registered broker-dealers as subscribers to its trading system platform, which traded over-the-counter securities like microcap or penny stocks. Despite being required to comply with the BSA and its regulations, the broker-dealer failed to adopt or implement adequate AML policies and procedures. The SEC alleged that the broker-dealer did not surveil, investigate, or file SARs on numerous transactions indicating possible fraudulent activity or lacking a lawful business purpose. The SEC highlighted several red flags the broker-dealer failed to address, such as large volume trading, one-sided trading with price increases, and trading activities involving pre-arranged or wash trades. Additionally, the broker-dealer did not investigate transactions involving subscribers known to be subjects of criminal, civil or regulatory actions.
The broker-dealer’s surveillance system alerted potentially suspicious trading activity, but the firm did not review these alerts. Between January 2020 and June 2021, the system generated 1,862 alerts (about 310 alerts per month). However, the compliance team devoted only about five hours per month to review these alerts, which the SEC found insufficient. Consequently, the broker-dealer failed to file any SARs during the relevant period despite suspicious trading activity. The broker-dealer neither admitted nor denied these findings.
CFTC orders bank to pay $5M for swap reporting violations
On August 26, the CFTC issued an order against a bank for allegedly failing to correctly report millions of swap transactions to a registered swap data repository, in violation of a prior CFTC order, and for failing to properly supervise its swap dealer business. According to the consent order, the CFTC found that from at least 2018 through 2023, the respondent violated multiple sections of the Commodity Exchange Act and CFTC regulations related to swap data reporting, engaged in improper supervision of its swap dealer business, and failed to comply with a 2019 CFTC order.
The respondent self-reported the violations and agreed to engage an outside compliance consultant to review and provide advice regarding its compliance program. The consent order imposed a $5 million civil monetary penalty. The CFTC acknowledged the respondent’s cooperation, which, according to the CFTC, resulted in a reduced civil monetary penalty.
FINRA charges member firm with Regulation Best Interest violations
On August 5, FINRA accepted a Letter of Acceptance, Waiver, and Consent (AWC) against a member firm for three alleged violations related to the failure to maintain policies and procedures and supervisory systems in compliance with federal law. First, the firm allegedly failed to establish and maintain written policies and procedures in compliance with Regulation Best Interest (Reg BI) since June 2020. According to FINRA, this lapse led to violations of the Securities Exchange Act Rule 15l-1(a)(1) and breaches of FINRA Rules 3110 and 2010. The firm also allegedly neglected its obligations under Exchange Act Rule 17a-14, which mandates the preparation of a customer relationship summary (Form CRS). From June 2020 to July 2023, FINRA claims the firm did not have a proper supervisory system tailored to ensure compliance with its Form CRS obligations. This oversight resulted in additional violations of FINRA Rules 3110 and 2010.
Last, the firm allegedly failed to file necessary documents in a timely manner for three private placement offerings sold to retail investors between April 2020 and March 2022. These filings were allegedly made almost two years late, and only after specific requests from the regulatory authority. The firm’s supervisory system was also lacking according to FINRA, as it designated an individual no longer associated with the firm to oversee these filings, violating FINRA Rules 3110 and 2010. The firm consented to a censure and a $60,000 fine as part of the settlement. Additionally, a senior management member must certify within 60 days that the firm has remediated the identified issues and implemented compliant policies and procedures.
SEC’s Gensler discussed recent enforcement actions and artificial intelligence risks
On August 1, the Chair of the SEC, Gary Gensler, addressed the Strike Force on Unfair and Illegal Pricing emphasized the agency’s commitment to combating deceptive, fraudulent and anticompetitive practices. The Chair highlighted the SEC’s recent enforcement efforts and rulemaking projects to enhance competition. His remarks focused on the transformative potential of AI and its implications for the securities markets. Gensler acknowledged that while AI offers substantial benefits, it also presents new challenges for regulatory agencies, like how to address bad actors that could potentially use AI to deceive or defraud investors.
The Chair also raised concerns about the anticompetitive risks associated with AI, such as the fact that few tech platforms dominate the current AI market. The Chair warned that AI could be used to manipulate market systems or signal to competitors about pricing, thus undermining competition. In conclusion, Gensler expressed a commitment to collaborating with other agencies to address the challenges posed by AI in the financial sector. The remarks demonstrated the SEC’s proactive stance in adapting to technological advancements while maintaining its core mission of protecting investors and ensuring fair, orderly and efficient markets.
FINRA fines broker $165K for lack of supervisory controls and market access rule violations
Recently, FINRA accepted a Letter of Acceptance, Waiver, and Consent (AWC) against a broker providing self-directed, online brokerage services to institutional and retail customers. The broker previously received a $595,000 fine in April 2015 for allegedly failing to supervise potentially manipulative trading and failing to have reasonable market access controls and procedures. This month’s AWC was based on similar alleged conduct, finding from November 2017 to January 2020, the broker allegedly failed to establish a supervisory system prohibiting potentially manipulative trading in violation of FINAR Rules 3110 and 2010. FINRA supervision found the broker implemented a third-party surveillance system without tailoring it to the firm’s business model or order flow, assigned one trader ID number for each customer even when the account had more than one trader, and closed alerts without reasonable follow-up or investigation.
The broker also allegedly violated Section 15(c)3-5 of the Securities Exchange Act, Exchange Act Rule 15c3-5, and FINRA Rule 2010 during that same period by failing to maintain market access controls and procedures. FINRA alleged the broker did not implement a system of controls to set the appropriate credit thresholds for each customer and instead relied on clearing firms. FINRA also alleged the broker failed to provide documentation evidencing how customers’ credit controls were established or designed. Due to these violations, FINRA issued a censure, a $165,000 fine, and a certification in writing that the issues have been remedied within 90 days.