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SEC Issues Investor Bulletin Concerning Fraud Related to Initial Coin Offerings
On August 28, the SEC Office of Investor Education and Advocacy (OIEA) released an Investor Bulletin about the risks associated with investing in companies that claim to be related to, or assert that they are engaged in, Initial Coin Offerings (ICOs). ICOs are also known as coin or token launches, and sales are often used to raise capital. However, the OIEA warns investors that while some companies employ ICOs for lawful opportunities, the agency is cracking down on companies who use emerging technologies like ICOs for fraudulent purposes, such as announcing ICOs in order to affect the price of their common stock. The OIEA issued guidance, including (but not limited to) the following, to help investors spot potential fraud:
- Investors should consider past trading suspensions as warning signs of possible microcap fraud when considering whether to invest, especially if there is a lack of current, reliable information about the company and its stock offerings.
- Investors should be cautious about “pump-and-dump” schemes where companies manipulate the price of a stock to urge investors to buy quickly through false and misleading statements, and then unload shares of those stocks at artificially inflated prices, causing investors to lose money.
- Investors should understand the risks of investing with companies that are not required to file reports with the SEC (“non-reporting companies”);
- Investors should be very cautious of stock promotions offered by companies that do not provide details on whether the ICOs are compliant with securities law.
The bulletin also includes links to additional investor resources, including an Investor Bulletin on ICOs.
SEC Issues Regulatory Notice Approving Amendments to FINRA Arbitration Proceedings
Earlier this month, the SEC released Regulatory Notice 17-25 approving amendments to FINRA customer and industry arbitration procedures, which will impact Rules 12402, 12403, and 13403. The changes will require the Director of FINRA’s Office of Dispute Resolution to make lists of arbitrators available to all parties at the same time “within approximately 30 days after the last answer is due.” Party agreements to extend answer due dates will no longer have any bearing on when the arbitrator list is provided. The amendments will affect cases filed on or after September 18, 2017.
DOL Announces Intention to Delay Portions of Fiduciary Rule Exemptions
On August 9, the U.S. Department of Labor (DOL) filed a notice of administrative action in the U.S. District Court for the District of Minnesota as part of an ongoing lawsuit between the DOL and a wealth management firm. In the notice, the DOL said that it has submitted a proposal (text currently unavailable) to the Office of Management and Budget to delay the fiduciary rule’s second applicability date to July 1, 2019, instead of taking effect January 1, 2018 as previously announced (portions of the rule, however, took effect June 9, 2017). (See previous InfoBytes coverage here.) The rule—which expands the definition of who qualifies as a “fiduciary” under ERISA and the Internal Revenue Code—will allow for a delay of applicability under the proposal for certain exemptions, such as (i) “Best Interest Contract Exemption”; (ii) “Class Exemption for Principal Transactions in Certain Assets Between Investment Advice Fiduciaries and Employee Benefit Plans and IRAs”; and (iii) “Prohibited Transaction Exemption . . . for Certain Transactions Involving Insurance Agents and Brokers, Pension Consultants, Insurance Companies, and Investment Company Principal Underwriters.”
SEC Reaches Settlement with Broker-Dealer Over Alleged Sale of Unregistered Stocks and Failure to File SARs
On July 28, the SEC announced it had reached a settlement in an administrative proceeding against a broker-dealer firm for allegedly selling hundreds of millions of unregistered penny stock shares and failing to file Suspicious Activity Reports (SARs) for over $24.8 million in suspicious transactions with the Financial Crime Enforcement Network. Bank Secrecy Act regulations require a broker-dealer to file SARs if it “knows, suspects, or has reason to suspect that the transaction . . . involves funds derived from illegal activity or is intended . . . to hide or disguise funds” to evade anti-money laundering (AML) rules. A broker-deal must also file SARs if there is no apparent lawful purpose for the transaction or if the transaction is to facilitate criminal activity. According to the settlement, the firm’s actions violated the Securities Act and Exchange Act. In addition to being censured and agreeing pay a $200,000 penalty, the firm will no longer accept the deposit of stocks valued under $5.00 and will retain an independent consultant to assist with mandatory enhancements to the firm’s AML policies and procedures.
FINRA Announces Head of Enforcement, Consolidates Enforcement Functions into Single Department
On July 26, the Financial Industry Regulatory Authority (FINRA) announced the promotion of Susan Schroeder to Executive Vice President and Head of Enforcement. Previously, Ms. Schroeder served as FINRA Senior Vice President and Deputy Chief of Enforcement, and she began serving as acting Head of Enforcement around the start of this year. Schroeder will report directly to CEO Robert Cook. FINRA also announced plans to consolidate its existing enforcement teams—“one handling disciplinary actions related to trading-based matters found through Market Regulation’s surveillance and examination programs, and the other handling cases referred from other regulatory oversight divisions including Member Regulation, Corporate Financing, the Office of Fraud Detection and Market Intelligence, and Advertising Regulation”—into a single unit led by Schroeder. This reorganization was prompted by FINRA360, the organization’s comprehensive self-evaluation and improvement examination.
SEC Issues Investigative Report: Federal Securities Laws Apply to Virtual Organizations
On July 25, the SEC issued an investigative report stating that federal securities laws apply to anyone who offers and sells securities in the U.S., regardless of the manner of distribution or whether dollars or virtual currencies are used to purchase the securities. The SEC’s Report of Investigation (Report) advises users to make sure they are compliant with federal securities laws when raising capital through Decentralized Autonomous Organizations (DAO) or other forms of distributed ledgers or blockchain technology. These offering are often referred to as “Initial Coin Offerings” (ICOs) or “Token Sales.”
The Report originates from an Enforcement Division inquiry into whether the DAO—and affiliated entities—“violated federal securities laws with unregistered offers and sales of DAO Tokens in exchange for ‘Ether,’ a virtual currency.” According to the SEC, the DAO, which has been described as a “crowdfunding contract,” has not met any of the specific Regulation Crowdfunding exemption requirements issued earlier this year by the agency. These regulations were previously discussed in InfoBytes. In its Report, the SEC stated that the individuals involved in a 2016 virtual currency offering that was later hacked will not face charges, but will rather serve as a warning to the industry that people who offer and sell securities in the U.S. must follow the law. In light of this discussion, the SEC’s Office of Investor Education and Advocacy issued an Investor Bulletin to educate investors about the benefits and risks of ICOs, which promoters have begun to use to sell virtual currencies.
“Investors need the essential facts behind any investment opportunity so they can make fully informed decisions, and today's Report confirms that sponsors of offerings conducted through the use of distributed ledger or blockchain technology must comply with the securities laws,” said William Hinman, SEC Director of the Division of Corporation Finance.
Regulators Coordinate Review of Volcker Rule Application to Foreign Funds
On July 21, five U.S. financial regulators announced that they would not take action against foreign banks for qualifying foreign excluded funds, subject to certain conditions, under the Volcker Rule for a period of one year as they review the treatment of these types of funds under current implementing regulations. The regulators, which include the Federal Reserve Board, FDIC, OCC, SEC, and Commodity Futures Trading Commission, issued a joint statement to address concerns raised as to whether certain foreign excluded funds may fall within the definition of “banking entity” under the Bank Holding Company Act and therefore be subject to the Volcker Rule.
“A number of foreign banking entities, foreign government officials, and other market participants have expressed concern about the possible unintended consequences and extraterritorial impact of the Volcker Rule and implementing regulations for certain foreign funds,” according to the joint statement. The regulators noted that the review will allow time to consider the appropriate course of action to address these concerns, including whether congressional action may be necessary.In addition, the regulators stressed that the joint statement “does not otherwise modify the rules implementing section 619 [of the Dodd-Frank Act] and is limited to certain foreign excluded funds that may be subject to the Volcker Rule and implementing regulations due to their relationships with or investments by foreign banking entities.”
Global Bank and U.S. Subsidiaries Fined $246 Million for Deficiencies in Internal Foreign Exchange Trading Controls
On July 17, the Board of Governors of the Federal Reserve (Board) fined a global bank and two of its U.S. subsidiaries $246 million for allegedly lacking appropriate oversight and controls to ensure the bank’s foreign exchange (FX) trading activities were in compliance. According to the cease and desist order, the Board alleged that the bank’s “deficient policies and procedures” prevented it from detecting unsafe and unsound conduct and communications between bank traders and traders at other financial institutions concerning their trading positions. In addition to the fine, the bank is required to improve its oversight and controls over its FX trading activities, submit a written plan to improve its compliance risk management program, and provide an enhanced written internal audit program, subject to Board approval. Furthermore, the bank is prohibited from re-employing any individuals involved in the illegal communications.
It was noted in the order that the bank conducted a review of its FX trading activities covering the investigation time period, identified and reported the illegal conduct to the Board and the Federal Reserve Bank of New York, and fully cooperated with the investigation. Improvements to address identified deficiencies have already begun.
SEC Chairman Outlines Regulatory Agenda
On July 12, SEC Chairman Jay Clayton spoke at the nonpartisan Economic Club of New York about the principles behind his regulatory agenda. In addition to outlining the SEC’s three-part mission on investor protection, market order and efficiency, and capital formation, Clayton stressed the need for cooperation with domestic and foreign regulators to ensure effective, sound regulatory approaches. Noting the SEC’s coordination with the Commodity Futures Trading Commission (CFTC) on issues concerning cybersecurity and swap markets specifically, Clayton highlighted plans to continue to work with the CFTC, under the guidance of Title VII of the Dodd-Frank Act, to “reduce unnecessary complexity as well as costs to both regulators and market participants.” The SEC also plans to continue to encourage strong enforcement and examination programs.
International Bank Settles RMBS Claims with FHFA for $5.5 Billion
On July 12, the Federal Housing Finance Agency (FHFA), as conservator of Fannie Mae and Freddie Mac (GSEs), announced a $5.5 billion settlement with an international bank. The settlement resolves FHFA’s claims, lodged in a federal lawsuit in the District of Connecticut, that the bank violated federal and state securities laws in relation to residential mortgage-backed securities (RMBS) trusts purchased by the GSEs between 2005 and 2007. The settlement covers all RMBS “issued, sponsored, sold, or underwritten by . . . [d]efendant between January 1, 2004 and December 31, 2008,” which is intended to include all securities for which FHFA brought claims against the bank in the District of Connecticut action. Under the terms of the agreement, the bank will pay $4.525 billion of the settlement amount to Freddie Mac, and approximately $975 million to Fannie Mae.