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Financial Services Law Insights and Observations


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  • SEC settles with company selling securities through DeFi platform


    On August 6, the SEC announced a settlement with two individuals and their company for the alleged unregistered sale of over $30 million of securities using smart contracts and decentralized finance technology, and for misleading investors regarding the operations and profitability of their business. According to the SEC’s order, the company offered and sold securities in unregistered offerings through a program from February 2020 to February 2021, which used smart contracts to sell two types of digital tokens: one type that could be purchased using specified digital assets and paid 6.25 percent in interest; and the other type that purportedly provided holders certain voting rights, some excess of profits, and the ability to profit from resales in the secondary market. The SEC alleged that the company violated provisions of the Securities Act, such as Section 5(a) and 5(c), by offering and selling securities without having a registration statement filed or in effect. In addition, the company violated Section 17(a) of the Securities Act, Section 10(b) of the Exchange Act, and Rule 10b-5 thereunder, by making materially false statements and engaging in other deceptive acts regarding business operations and profitability. The order, which the company consented to without admitting or denying the findings, imposes a civil money penalty of $125,000 to each individual and a total of $12,849,354 in disgorgement. The order also provides that the company must cease and desist from committing or causing any future violations of the Exchange Act. 

    Securities Digital Assets SEC Cease and Desist Cryptocurrency Securities Exchange Act

  • District Court finds that investors qualify for SEC whistleblower protections


    On July 21, the U.S. District Court for the Southern District of New York ruled that the SEC’s whistleblower protection rule extends to investors. In June 2020, a Nevada-based company and its owner (collectively, “defendants”) filed a motion to dismiss, strike portions of, and enter judgment on the pleadings of an amended complaint filed by the SEC which alleged, among other things, that the defendants violated Rule 21F-17 of the Securities Exchange Act. Rule 21F-17 “prohibits any ‘person’ from taking ‘any action to impede an individual from communicating directly with the Commission staff about a possible securities law violation, including enforcing, or threatening to enforce, a confidentiality agreement . . . with respect to such communications.’” The defendants argued that the SEC’s rulemaking authority extends only to “whistleblower-employees,” claiming they “were not in an employer-employee relationship with those individuals whom the SEC claims were impeded (that is, investor-victims),” and objected to a magistrate judge’s report and recommendation (R&R) “as it relates to the SEC’s claim for impermissible impeding of Rule 21F-17 in violation of the Exchange Act.” The SEC countered that “Section 21F is not limited to protecting whistleblowers in the employee-employer relationship, and as such, Rule 21F-17’s application to any ‘person’ is a proper exercise of its rulemaking authority.”

    On review, the court sided with the SEC in finding that Section 21F broadly defines “[w]histleblower” as “any individual who provides . . . information relating to a violation of the securities laws” to the SEC, ruling that Rule 21F-17 “falls squarely within the SEC’s statutory authority to issue ‘necessary and appropriate’ regulations to implement Section 21F of the Exchange Act.” The court further held that “[w]hile certain portions of Section 21F provide anti-retaliation protections specific to those whistleblowers who are employees, nothing in the statute’s text nor the supporting documents indicates that Congress intended to protect only those whistleblowers who are employees.”

    Courts SEC Whistleblower Securities Exchange Act

  • SEC charges liability company with Exchange Act violations


    On June 23, the SEC announced charges against a New York-based limited liability firm for Securities Exchange Act violations because the firm allegedly used language in the firm’s compliance manual that prohibited potential whistleblowers from speaking out to regulators. According to the order, over a four year span, the firm’s compliance manual stated that employees were “strictly prohibited from initiating contact with any Regulator without prior approval from the Legal or Compliance Department,” and that violation of this policy may result in “disciplinary action by the Firm.” The order noted, however, that the agency was “unaware of any specific instances” where an employee of the firm was prevented from disclosing to the SEC staff about possible violations. In 2018 and 2019, the firm also provided annual compliance training to its employees that allegedly included similar language. Specifically, a slide in the training contained language that prohibited employees “from initiating contact with any regulator without prior approval from Legal or Compliance, including conversation[s] regarding an individual’s registration status with FINRA.” The SEC further alleged that the firm’s employees were also required to comply with the code of conduct maintained by the firm’s indirect parent company, but acknowledged that the code was not meant to restrict employees’ whistleblower protections, and employees were not prohibited from reporting to government agencies. However, the firm’s manual also noted that “personnel should follow the more restrictive” of the various policies, “absent explicit direction to the contrary.” The order noted that the firm took remedial steps to correct the issues, including altering the language in the compliance manual to instead advise employees of their right to communicate with regulators about possible concerns without obtaining prior approval. The firm communicated the revisions to its employees by administering a compliance alert, which linked to the revised manual. The SEC charged the firm with violating Rule 21F-17 of the Securities Exchange Act and ordered the firm, to cease and desist for committing future violations of Rule 21F-17 and pay a $208,912 penalty.

    Securities SEC Enforcement Securities Exchange Act

  • SEC sues mutual fund for diverting investor funds into shell companies


    On June 21, the SEC filed a complaint against a Cayman Islands-registered mutual fund and its operators (collectively, “defendants”) in the U.S. District Court for the Southern District of New York alleging they diverted millions of dollars in investor funds to shell companies under the defendants’ control through uncollateralized loan transactions, and issued “false or misleading statements of material facts to investors to disguise their misconduct.” According to the SEC, the defendants have also blocked investors from redeeming the roughly $106 million they invested in the fund, and have transferred $64 million of the investors’ deposits into the fund’s brokerage account, from which the assets were allegedly “subject to further dissipation and misappropriation.” The SEC’s complaint alleges violations of the antifraud provisions of the Securities Act of 1933 and the Securities Exchange Act of 1934, and seeks a permanent injunction against the defendants, a permanent ban prohibiting the participation in future securities offerings through entities owned or controlled by the defendants, disgorgement of ill-gotten gains, civil penalties, and an asset freeze.

    Securities SEC Fraud Securities Exchange Act Enforcement

  • Broker-dealer settles with SEC for failing to file SARs


    On May 12, the SEC announced a settlement with a broker-dealer for allegedly violating the Securities and Exchange Act by failing to consistently implement its anti-money laundering (AML) program and file Suspicious Activity Reports (SARs) despite knowing individuals were attempting to gain unauthorized access to retirement accounts. According to the SEC’s order, from September 2015 through October 2018, the broker-dealer allegedly knew that individuals were attempting to gain access, or had gained access, to plan participants’ retirement accounts through the use of improperly obtained personal identifying information. The SEC alleged that, despite this knowledge, the broker-dealer failed to file approximately 130 SARs in cases where it had detected the suspicious activity and, in the roughly 297 SARs that it did file, failed to include certain required information linked to the bad actors, such as URL addresses, IP addresses, and other electronic identifying information. The order requires the broker-dealer, who has neither admitted nor denied the SEC’s allegations, to cease and desist from future violations and pay a $1.5 million penalty. The SEC acknowledged the broker-dealer’s significant cooperation in the investigation and subsequent remedial efforts.

    Securities Enforcement SARs Financial Crimes Anti-Money Laundering Securities Exchange Act

  • SEC settles with blockchain company over unregistered ICO


    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.

    Securities Digital Assets SEC Enforcement Initial Coin Offerings Securities Exchange Act

  • FINRA updates guidance on fingerprinting requirements

    Federal Issues

    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.

    Federal Issues Covid-19 FINRA SEC Securities Exchange Act

  • SEC charges company and CEO for misleading statements concerning N95 masks

    Federal Issues

    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.

    Federal Issues SEC Enforcement Courts Securities Exchange Act Covid-19

  • SEC’s disgorgement authority examined during Supreme Court oral arguments


    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.”

    Courts Federal Issues SEC Enforcement U.S. Supreme Court Disgorgement Civil Money Penalties Securities Exchange Act Sarbanes-Oxley Liu v. SEC

  • DOJ, SEC settle with national bank for $3 billion over sales-compensation practices

    Federal Issues

    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. 

    Federal Issues DOJ Regulator Enforcement Enforcement SEC Securities Exchange Act FIRREA Incentive Compensation


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