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On June 4, the SEC announced it had filed a lawsuit in the U.S. District Court for the Southern District of New York against a tech company issuer for allegedly raising approximately $100 million through an unregistered initial coin offering. According to the complaint, the issuer failed to provide required disclosures to investors and did not register the offer or sale of its digital tokens with the SEC, as required by Section 5 of the Securities Act of 1933. The SEC contends that the issuer marketed the digital tokens as an investment opportunity and told investors that they could earn future profits from the issuer’s efforts to create, develop, and support a digital “ecosystem.” According to the SEC, “[f]uture profits based on the efforts of others is a hallmark of a securities offering that must comply with the federal securities laws.” The SEC’s suit seeks a permanent injunction, disgorgement of profits plus interest, and a civil penalty.
On June 3, the SEC announced awards totaling $3 million to two whistleblowers for jointly volunteering information that led to a successful enforcement action involving an alleged securities law violation that impacted retail investors. The SEC noted that the whistleblowers “undertook significant and timely steps to have their employer remediate the harm caused by the alleged violations.” The order does not provide any additional details regarding the whistleblowers or the company involved in the enforcement action. Since the program’s inception in 2012, the SEC has awarded approximately $384 million to 64 whistleblowers.
On June 3, the Federal Housing Finance Authority (FHFA) officially launched the Uniform Mortgage-Backed Security (UMBS), a common security through which Fannie Mae and Freddie Mac mortgage-backed securities will be issued. FHFA Deputy Director Robert Fishman noted that the new UMBS will bring “additional liquidity and efficiency to the market.” Moreover, “[b]y addressing structural issues and trading disparities, the UMBS will benefit taxpayers and the nation's housing finance system.” As previously covered by InfoBytes, in March 2018, FHFA announced the UMBS, stating that it would replace all current offerings of mortgage-backed securities that occur in the to-be-announced (TBA) forward market. The FHFA also indicated that the UMBS would be issued using the Common Securitization Platform (CSP) through the Enterprises’ joint venture, Common Securitization Solutions (CSS).
On May 24, the SEC announced a $4.5 million award to a whistleblower who reported concerns internally to his or her company and also to the SEC within 120 days of reporting to the company. This marked the first time the SEC issued an award to a claimant under the provision of the whistleblower rules that were “designed to incentivize internal reporting by whistleblowers who also report to the SEC within 120 days.” The company reported the allegations, and later the findings of the internal investigation it launched as a result of the claimant’s tip, to the SEC and another federal agency. The SEC initiated its own investigation after the company self-reported, which resulted in a successful enforcement action and the $4.5 million award to the whistleblower that originated the allegations. The order does not provide any additional details regarding the whistleblower or the company involved in the enforcement actions. Since the program’s inception in 2012, the SEC has awarded approximately $381 million to 62 whistleblowers.
On April 25, the New York Supreme Court, Appellate Division held that a trustee for two residential mortgage-backed securities (RMBS) trusts is entitled to file an amended complaint concerning “express breach of contract claims.” The issue arose from whether the sponsor breached its agreements with the trustee when it allegedly failed to disclose breaches of representations and warranties discovered during a due diligence review of the RMBS trusts after the transactions closed. According to the opinion, the sponsor claimed that no fraud or misrepresentations had occurred with respect to the loans, but it was later discovered that this was not true. However, the sponsor still moved to dismiss, arguing it was not bound under the mortgage purchase agreements to disclose any breach of the representations and warranties. The trial court dismissed the claims and blocked the trustee from filing an amended complaint after it determined the sponsor was not obligated to relay the loans’ issues after they were discovered.
On review, the appeals court found that the relevant contractual language, requiring the sponsor, upon discovery of any breach to give written notice of the breach to itself, was ambiguous, but opined that “[a]llowing the clause to remain as written would render this provision meaningless”—an important fact since “courts should avoid interpretations that would render contractual language mere surplusage.” The trustee claimed that because the sponsor is included on the list of parties required to provide notice, there must be another unnamed party, other than the sponsor, available to receive notice, whereas the sponsor argued that its inclusion on the list of parties required to give notice was “due to ‘alleged drafting imperfections’” since it is the party that is entitled to receive such notices. Because both parties presented “reasonable competing interpretations,” the appeals court noted, additional proceedings are necessary.
On April 24, the Financial Industry Regulatory Authority (FINRA) announced the formation of a new office, the Office of Financial Innovation, that will act as a central point of coordination for issues related to financial innovation by FINRA members. The new office, which is an outgrowth of FINRA’s Innovation Outreach Initiative (previously covered by InfoBytes here), will collaborate with various FINRA teams as well as regulators, investors, and other stakeholders to encourage the use of fintech in a way that strengthens market integrity and protects investors. The new office also will incorporate FINRA’s existing Office of Emerging Regulatory Issues, which focuses on analyzing new and emerging risks and trends related to the securities market.
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 April 16, the SEC’s Office of Compliance Inspections and Examinations issued a Risk Alert to discuss compliance issues related to Regulation S-P—the SEC’s primary rule regarding privacy notices and safeguard policies—and to provide assistance to registered investment advisors and broker-dealers (registrants) when issuing compliant privacy and opt-out notices. Regulation S-P requires registrants to provide customers with a clear and conspicuous notice accurately reflecting its privacy policies and practices, plus any options to opt out of sharing certain non-public personal information with nonaffiliated third parties. The notice must be sent annually throughout the duration of the customer relationship. Regulation S-P also requires registrants to implement written policies and practices reasonably designed to ensure that customer records and information are secure and protected against unauthorized access. The Risk Alert provides examples of common Regulation S-P compliance deficiencies and weaknesses, and advises registrants to “review their written policies and procedures, including implementation of those policies and procedures, to ensure that they are compliant with Regulation S-P.”
On April 12, the DOJ announced that a multinational corporation will pay $1.5 billion in a settlement resolving claims brought under the Financial Institutions Reform, Recovery, and Enforcement Act of 1989 (FIRREA) that a financial services subsidiary of the corporation misrepresented the quality of loans it originated in connection with the marketing and sale of residential mortgage-backed securities (RMBS). According to the DOJ, between 2005 and 2007, the majority of the mortgage loans sold by the subsidiary for inclusion in RMBS did not comply with the quality representations made about the loans. Specifically, the loan analysts allegedly approved mortgage loans that did not meet criteria outlined in the company’s underwriting guidelines, as they would receive additional compensation based on the number of loans they approved. The DOJ asserts that there were inadequate resources and authority for the subsidiary’s quality control department, resulting in deficiencies in risk management and fraud controls. Additionally, if an investment bank were to reject a loan due to defects in the loan file, the DOJ alleges the subsidiary would attempt to find a new purchaser, without disclosing the previous rejection or identifying the alleged defects. The corporation does not admit to any liability or wrongdoing, but agreed to pay a $1.5 billion civil money penalty to resolve the matter.
On April 3, the SEC issued a no-action letter to a Delaware-based airline chartering services company not recommending enforcement action for offering and selling “tokens” without registration under the SEC Act. According to the letter, the SEC relied upon the company’s counsel’s opinion, which assured that consumers are purchasing the tokens solely for prepaid “air charter services and not for investment purposes or with an expectation to earn a profit,” in determining that the “tokens” were not securities. Additionally, the SEC’s relief considered numerous other factors such as: (i) the platform for conducting the sale of the tokens will “be fully developed and operational” at the time any tokens are sold and funds derived from token sales will not be used to develop the platform; (ii) consumers will be able to immediately use the tokens for their intended functionality (i.e., to purchase air charter services) at the time of sale; (iii) the company will restrict the transfer of tokens to company wallets only and not to external wallets; (iv) the tokens will be sold for one dollar to be used solely on the platform to purchase air charter services, and will be treated as having a value of one dollar; (v) if the company offers to repurchase tokens, it will do so at a discount to the face value of the tokens that the holder seeks to resell to the company, unless a court orders the company to liquidate the tokens; and (vi) the tokens will not be marketed in such a way that there is a perceived potential for an increase in the token’s market value.
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