Subscribe to our InfoBytes Blog weekly newsletter and other publications for news affecting the financial services industry.
On May 28, the SEC announced a settlement with a California-based blockchain services company resolving allegations that the company conducted an unregistered initial coin offering (ICO) of digital asset securities. According to the order, the company raised over $25 million by selling “Consumer Activity Tokens” to nearly 9,500 investors, including U.S. investors, to raise capital to “develop, administer, and market a blockchain-based search platform for targeted consumer advertising.” The company allegedly told investors that the tokens would increase in value and made the tokens available on third-party digital asset trading platforms after the ICO. However, the SEC found that the tokens constituted securities, and that the company allegedly violated Sections 5(a) and 5(c) of the Securities Act by distributing the tokens without having the required registration filed or in effect, nor did it qualify for an exemption to the registration requirements.
The order, which the company consented to without admitting or denying the findings, imposes a $400,000 penalty, and requires the company to disgorge $25.5 million and pay approximately $3.4 million in prejudgment interest. Additionally, the company is required to surrender all its remaining tokens to the fund administrator so they can be permanently disabled, publish notice of the order, and request the removal of the distributed tokens from all digital asset trading platforms.
On May 28, FINRA updated frequently asked questions guidance regarding relief from certain fingerprinting requirements. The guidance notes that, on May 27, the SEC extended its order providing a temporary relief from fingerprinting requirements of the Securities Exchange Act Rule 17f-2 for FINRA members until June 20, 2020. Because FINRA already provided notification to the SEC in March on behalf of its members, their employees, and associated persons, such individuals may continue to rely on the commissioner’s order and FINRA’s notification. However, for an individual seeking registration pursuant to the submission of a Form U4, a FINRA member firm seeking to rely on temporary exemptive relief for registered persons must comply with FINRA’s guidance with respect to FINRA Rule 1010.
On April 28, the SEC announced that it filed suit in the U.S. District Court for the Southern District of Florida against a company and its CEO (defendants) for violating the Securities Exchange Act of 1934 by making false and misleading statements concerning their ability to source and supply N95 masks for the Covid-19 virus. The SEC alleges that the defendants’ actions sought to mislead investors because they “never had either a single order from any buyer to purchase masks, or a single contract with any manufacturer or supplier to obtain masks, let alone any masks actually in its possession.” Following regulatory inquiries (and an SEC March 26 order that temporarily suspended trading in the securities of the company), the SEC alleges in the complaint that the CEO issued a press release stating that the company never had masks available to sell. The SEC seeks injunctive relief and civil penalties against the defendant, as well as an officer-and-director bar against the CEO.
On March 3, the U.S. Supreme Court heard oral arguments in Liu v. SEC. As previously covered by InfoBytes, the principal question at issue in this case is whether the SEC’s authority to seek “equitable relief” permits it to seek and obtain disgorgement orders in federal court. Petitioners—a couple found to have defrauded investors and ordered to disgorge $26.7 million by a California federal court—argued that disgorgement is not a form of “equitable relief” available to the SEC. Respondent SEC contended that Congress enacted several statutes that anticipated the SEC’s use of disgorgement, including the Securities Exchange Act and the Sarbanes-Oxley Act, and that historically, disgorgement has been used as an equitable remedy to deny wrongdoers of their ill-gotten gains.
Counsel for the petitioners made three primary arguments before the Court: (i) the SEC is only authorized to use the powers conferred upon it by Congress and disgorgement is not one of them; (ii) though the statute allows the SEC to seek equitable relief, disgorgement as the SEC has used it is akin to a penalty and “penalties are not equitable relief.”; and (iii) “Congressional silence…does not give an agency any authority to act, much less the authority to punish” in a manner that exceeds its existing statutory authority
Petitioners’ counsel fielded questions from Justices Ginsburg, Alito, and others that probed the limits of the petitioners’ position. The justices asked, among other things, whether disgorgement could ever be ordered by the SEC; whether it could be ordered if the profits are paid out to injured parties; and whether the Court’s holding in Kokesh v SEC, that disgorgement as a penalty should be controlling only when determining the applicable statute of limitations, which was the issue presented in that case. Petitioner’s counsel stated that “the rule should be, if you’re giving the money back to the investors, then [the SEC] can take it and not otherwise, because…then it’s just a punishment.”
Respondent’s counsel argued that the Court’s ruling in Kokesh was limited to determining the applicability of the statute of limitations. He also urged that “courts should continue to order disgorgement but compute it in accordance with traditional general equitable rules, not in accordance with any SEC-specific formula.” In response to a question from Justice Sotomayor regarding the proper recipient of disgorged funds, respondent’s counsel said that if the defrauded investors can be located, the SEC’s practice it to return disgorgement amounts to them. However, he noted that sometimes, such as in FCPA actions, there are no obvious victims to whom the money could be returned. Justice Kavanaugh asked if it would be proper for the Court to insist that the amounts received from a disgorgement order be returned to defrauded investors if at all possible. Respondent’s counsel conceded this would be within the Court’s authority, but added that the “core purposes of disgorgement are to prevent the wrongdoer from profiting from its own wrong and to deter future violations, and disgorgement can serve those traditional purposes, regardless of where the money ends up.”
On rebuttal, petitioner’s counsel asserted that “the scope of disgorgement has grown over time in part because it is not grounded in statutory text.” He contended that “there is no precedent for using an accounting to compel funds to be paid to the Treasury.” Justice Ginsburg pressed petitioner’s counsel regarding statutes that appear to be predicated on disgorgement being available. Petitioner’s counsel suggested those statutes might show that Congress was aware that courts were ordering disgorgement, but that was “not an authorization, and authorization is what’s needed…to inflict a penalty.” He closed by asking the Court to reverse the case, saying that the petitioners were already responsible to pay their entire gains from the fraud, and “anything more would go beyond the equitable principle that no individual should be permitted to profit from his or her own wrong.”
On February 21, the DOJ and SEC announced that one of the nation’s largest banks agreed to a settlement including a $3 billion monetary penalty to resolve investigations regarding their incentive compensation sales program. (See the DOJ’s Statement of Facts here). As previously covered by InfoBytes, the OCC also recently issued charges against five of the bank’s former executives, and announced settlements with the former CEO and operating committee members for allegedly failing to adequately ensure that the bank’s sales incentive compensation plans operated according to policy.
The SEC alleged in its Cease and Desist order that the bank violated the antifraud provisions of the Securities Exchange Act of 1934. The SEC’s press release states that in addition to agreeing to cease and desist from committing any future violations of the antifraud provisions, the bank agreed to a civil penalty of $500 million, which the SEC will return to harmed investors.
The bank also settled the DOJ’s civil claims under the Financial Institutions Reform, Recovery and Enforcement Act. According to the settlement, the bank accepted responsibility, cooperated in the resulting investigations, and has taken “extensive remedial measures.” In addition, the DOJ’s press release states that it entered into a three-year deferred prosecution agreement with the bank regarding the bank’s sales incentive compensation practices.
On February 19, the SEC announced a settlement with a blockchain technology company resolving allegations that the company conducted an unregistered initial coin offering (ICO). According to the order, the company raised approximately $45 million from sales of its digital tokens to raise capital to develop a digital asset trade-testing platform and to build a cryptocurrency-related data marketplace. The SEC alleges that the company violated Section 5(a) and 5(c) of the Securities Act because the digital assets it sold were securities under federal securities laws, and the company did not have the required registration statement filed or in effect, nor did it qualify for an exemption to the registration requirements. The order, which the company consented to without admitting or denying the findings, imposes a $500,000 penalty and requires the company to register its tokens as securities, refund harmed investors through a claims process, and file timely reports with the SEC.
On January 15, the SEC filed a brief in a pending U.S. Supreme Court action, Liu v. SEC. The question presented to the Court asks whether the SEC, in a civil enforcement action in federal court, is authorized to seek disgorgement of money acquired through fraud. The petitioners were ordered by a California federal court to disgorge the money that they collected from investors for a cancer treatment center that was never built. The SEC charged the petitioners with funneling much of the investor money into their own personal accounts and sending the rest of the funds to marketing companies in China, in violation of the Securities Act’s prohibitions against using omissions or false statements to secure money when selling or offering securities. The district court granted the SEC’s motion for summary judgment, and ordered the petitioners to pay a civil penalty in addition to the $26.7 million the court ordered them to repay to the investors. The petitioners appealed to the Supreme Court and in November, the Court granted certiorari.
The petitioners argued that Congress has never authorized the SEC to seek disgorgement in civil suits for securities fraud. They point to the court’s 2017 decision in Kokesh v. SEC, in which the Court reversed the ruling of the U.S. Court of Appeals for the Tenth Circuit when it unanimously held that disgorgement is a penalty and not an equitable remedy. Under 28 U.S.C. § 2462, this makes disgorgement subject to the same five year statute of limitations as are civil fines, penalties and forfeitures (see previous InfoBytes coverage here). The petitioners also suggested that the SEC has enforcement remedies other than disgorgement, such as injunctive relief and civil money penalties, so loss of disgorgement authority will not hinder the agency’s enforcement efforts.
According to the SEC’s brief, historically, courts have used disgorgement to prevent unjust enrichment as an equitable remedy for depriving a defendant of ill-gotten gains. More recently, five statutes enacted by Congress since 1988 “show that Congress was aware of, relied on, and ratified the preexisting view that disgorgement was a permissible remedy in civil actions brought by the [SEC] to enforce the federal securities laws.” The agency notes that the Court has recognized disgorgement as both an equitable remedy and a penalty, suggesting, however, that “the punitive features of disgorgement do not remove it from the scope of [the Exchange Act’s] Section 21(d)(5).” Regarding the petitioner’s reliance on Kokesh, the brief explains that “the consequence of the Court’s decision was not to preclude or even to place special restrictions on SEC claims for disgorgement, but simply to ensure that such claims—like virtually all claims for retrospective monetary relief—must be brought within a period of time defined by statute.”
In addition to the brief submitted by the SEC, several amicus briefs have been filed in support of the SEC, including a brief from several members of Congress, and a brief from the attorneys general of 23 states and the District of Columbia.
On April 19, the SEC announced that an online lending platform will pay a $3 million penalty to resolve allegations it miscalculated and materially overstated annualized net returns (ANR) to investors. According to the order, between 2015 and 2017, the company allegedly excluded securities linked to certain charged-off consumer loans from its calculation of ANR and allegedly failed to identify and correct the error, despite knowing that employees misunderstood the code underlying the ANR calculation and despite alleged complaints by investors. As a result, the company allegedly materially overstated the ANR to a total of more than 30,000 investors. After a large institutional investor complained to the company in April 2017, it notified investors of the misstatements and corrected the ANR in May 2017. In agreeing to a settlement, the company did not admit or deny the SEC’s findings, and the order acknowledges that the company has since instituted “a number of controls designed to prevent and detect similar errors in the future,” including new management supervision, quarterly reviews, and semi-annual testing.
On September 14, a New York federal district court granted class certification to a group of shareholder investors suing an American hedge fund management firm and two of its senior executives on the grounds that the investors were misled about a government investigation into the company’s activities in Africa. In finding that the proposed class met all the requirements for certification, the court certified a class of investors that held some of the more than 100 million outstanding shares between February 2012 and August 2014, the time period in which the firm allegedly violated the Securities Exchange Act. Plaintiffs claim that the firm told investors it was not under any pending judicial or administrative proceeding that might have a material impact on the firm, when in fact it was under DOJ and SEC investigation over allegations that its employees were bribing government officials in Africa. The allegations against the firm were made public in 2014 media reports detailing government scrutiny into its dealings in Africa.
Click here for prior FCPA Scorecard’s coverage of this matter.
On September 11, the U.S. District Court for the Eastern District of New York issued a ruling that the U.S. government can proceed with a case for purposes of federal criminal law against a New York-based businessman who allegedly made “materially false and fraudulent representations and omissions” connected to virtual currencies/digital tokens backed by investments in real estate and diamonds sold through associated initial coin offerings (ICOs). The defendant—who was charged with conspiracy and two counts of securities fraud for his role in allegedly defrauding investors in two ICOs—claimed that the ICOs at issue were not securities but rather currencies, and that U.S. securities law was unconstitutionally vague as applied to ICOs. However, the U.S. government asserted that the investments made in the tokens were “investment contracts” and thereby “securities” as defined by the Securities Exchange Act. The U.S. government further argued that the jury should apply the central test used by the U.S. Supreme Court in SEC v. W.J. Howey Co. to determine if a financial instrument “constitutes an ‘investment contract’ under the federal securities laws.” The judge commented that “simply labeling an investment opportunity as ‘virtual currency’ or ‘cryptocurrency’ does not transform an investment contract—a security—into a currency.” Moreover, while the judge cautioned that it was too early to determine whether the virtual currencies sold in the ICOs were covered by U.S. securities law, he concluded that a “reasonable jury” may find that the allegations in the indictment support such a finding.
- Daniel R. Alonso to discuss "How to become an AUSA" at the New York City Bar Association Minorities in the Courts Committee “How To” series
- Michelle L. Rogers and Kathryn L. Ryan to discuss “Fintech U.S. expansion” at the Tech Nation 3.0 cohort meeting
- Melissa Klimkiewicz to discuss "Flood insurance basics" at the NAFCU Virtual Regulatory Compliance School
- Jonice Gray Tucker to discuss "Compliance under Biden" at the WSJ Risk & Compliance Forum