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  • SEC to expand “dealer” definition after adoption of two rules

    Securities

    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.

    Securities Broker-Dealer Securities Exchange Act Securities Exchange Commission

  • SEC, DFPI charge unregistered crypto platform

    Securities

    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 DFPI SEC Registration Securities Exchange Commission Consent Order Digital Assets

  • SEC charges alleged hedge fund with defrauding $1.2 million from investors

    Financial Crimes

    On February 2, the SEC issued a complaint which charged a company for allegedly raising $1.2 million from 15 investors through an offer and sale of fraudulent securities for a hedge fund. The company raised this money from 2017-2018 and offered securities that would be used to form a hedge fund and invest in crypto-assets using “specific” investment strategies. (The company ostensibly managed the hedge fund, but the hedge fund never appeared to be created.) 

    The company made several misrepresentations which the SEC claimed violated Section 17(a) of the Securities Act of 1933 and Section 10(b) and Rule 10b-5 of the Securities Exchange Act of 1934. These alleged misrepresentations included the founder’s background and education, the demand for and size of the proposed hedge fund, and the investment scheme to grow a return for investors. The investors were given an investor pitch deck that put forth the hedge fund’s terms, investment strategy, and management team. Then, the investors gave a minimum investment of $1 million; however, the hedge fund investors were offered the opportunity to invest for less than $1 million through a separate entity.  

    Through this, the SEC alleged that the company violated the federal securities law and put forth two claims for relief. The SEC permanently enjoins the company from issuing, buying, offering, or selling any security, including crypto-assets. No civil monetary judgment has been offered. 

    Financial Crimes SEC Securities Cryptocurrency Enforcement

  • SEC rejects petition to amend the “no admit/no deny policy”

    Securities

    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. 

    Securities Securities Exchange Commission Enforcement Agency Rule-Making & Guidance Settlement

  • Bank to pay $18 million for violating a whistleblower protection rule

    Securities

    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. 

    Securities Securities Exchange Commission Whistleblower Enforcement Administrative Procedure Act Settlement Securities Exchange Act

  • FINRA report finds 70 percent of broker-dealer communications potentially violate crypto-asset rule.

    Securities

    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. 

    Securities FINRA Securities Exchange Commission Broker-Dealer

  • FINRA report covers new topics including cryptoassets

    Securities

    On January 9, FINRA released a report on regulatory oversight titled “2024 FINRA Annual Regulatory Oversight Report.” The report integrates FINRA’s regulatory operations programs as a source of information for firms to strengthen their compliance standards. The report outlines new topics, including Crypto Asset Developments, OTC Quotations in Fixed Income Securities, Advertised Volume, and the Market Access Rule.

    With respect to Crypto Asset Developments, the report focuses on surveillance themes and effective practices including best practices for due diligence. On the topic of OTC Quotations in Fixed Income Securities, the report highlights amendments to the rules governing publication of quotations by broker-dealers in a quotation medium. Further, with respect to Advertised Volume, FINRA highlights Rule 5210, which prohibits member firms from publishing transactions that are not believed to be a bona fide purchase or sale of a security.

    The report notes that the SEC’s Market Access Rule prohibits firms that provide market access from “jeopardiz[ing] their own financial condition.” Findings include insufficient controls and failure to consider additional data. Effective practices include pre-trade fixed-income financial controls and soft blocks, among others. The report also covers several other topics including Cybersecurity, AML Fraud and Sanctions, Reg BI and Form CRS, and Consolidated Audit Trail.

    Securities FINRA Cryptocurrency Broker-Dealer

  • SEC approves Bitcoin use in 11 exchange-traded products

    Securities

    On January 10, the SEC issued an order approving 11 exchange-traded products (ETPs) holding Bitcoin to be publicly traded. According to the order, the SEC found that the proposed ETPs are consistent with the Securities Exchange Act of 1934, specifically Section 6(b)(5), which requires that the rules prevent fraudulent and manipulative acts and practices and protect investors and the public interest. The SEC also found that the 11 proposed ETPs are consistent with Section 11A(a)(1)(C)(iii) which states that it is in the public interest to make the ETPs available to brokers, dealers, and investors. The order goes into further detail and outlines how the two subsections of the ‘34 Act are applied.

    As previously covered on InfoBytes, the SEC originally denied a similar application from a company but had to reexamine that company’s application following the D.C. Court of Appeals overturning of the SEC’s initial rejection. The appellate court alleged the SEC “acted arbitrarily and capriciously by denying the listing of [the company]’s proposed bitcoin ET[F],” and members of Congress also urged the Chair of the SEC to approve Bitcoin’s use within ETPs in a September 2023 letter (covered in InfoBytes here).

    Securities Exchange-Traded Funds Bitcoin Cryptocurrency Securities Exchange Act

  • SEC charges DAO for unregistered sale of crypto smart yield bonds

    Securities

    On December 22, 2023, the SEC announced a settlement with a decentralized autonomous organization (DAO) and a second settlement with its founders. The SEC alleged that the DAO failed to register with the Commission for its offering and sale of structured crypto-asset securities. The SEC additionally charged the organization for operating certain pools as unregistered investment companies. According to the SEC, the organization compared its structured crypto-asset securities to asset-backed securities and marketed them to the public. Furthermore, investors could acquire “senior” or “junior” interest which could be pooled and used to generate returns. The orders state that the structured crypto-asset securities attracted significant investments, totaling over $509 million, with fees paid to the organization by investors based on investment size and chosen yield.

    Securities Enforcement Cryptocurrency

  • SEC awards more than $28 million to seven whistleblowers

    Securities

    On December 22, 2023, the SEC announced awards totaling more than $28 million to seven whistleblowers whose information and assistance led to a successful SEC enforcement action. According to the redacted order, five of the whistleblowers provided significant information early in the investigation, participated in voluntary interviews, provided supporting documents to SEC staff, and identified key witnesses. The SEC also added that the whistleblowers made several attempts to internally report their concerns to company management. Two whistleblowers provided significantly less information than the other five later into the investigation, but still qualified for a percentage of the monetary sanctions collected in the covered action. Creola Kelly, Chief of the SEC’s Office of the Whistleblower, stated that “[t]hese whistleblowers provided valuable information and substantial assistance that played a critical role in the SEC returning millions of dollars to harmed investors.”

    One claimant’s whistleblower award application was denied because they did not communicate directly with the SEC staff responsible for the Covered Action Investigation and none of the information provided by the claimant was forwarded to the responsible staff. As such, the claimant did not provide original information that led to the successful enforcement action.

    Payments to whistleblowers are made out of an investor protection fund, established by Congress, which is financed entirely through monetary sanctions paid to the SEC by securities law violators.

    Securities Enforcement Whistleblower

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