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  • UK financial regulators issue new authority on securities “sandbox”

    Securities

    On April 3, the U.K.’s Financial Conduct Authority and the Bank of England released a consultation paper seeking comments on their proposal to implement the Digital Securities Sandbox (DSS), a new regime for financial firms to work on a testing ground for new technologies regarding digital assets. The goal of this testing ground would allow these firms to better issue, trade, and settle digital securities. The U.K. regulators believed that using securities on distributed ledgers (i.e., digital securities) has the potential to consolidate trade functions and reduce settlement times, reducing risk and streamlining processes. The DSS would oversee developing financial technologies, such as distributed ledger technology (DLT), during security trading. The three aims of the DSS would include promoting a safe and efficient financial system by removing potential barriers, protecting financial stability using DLT, and promoting market integrity. The securities regulated by the DSS include equities, bonds, money market instruments, and emissions allowances; however, unbacked cryptocurrencies (e.g., bitcoin) would remain outside the scope. The first sandbox entrants are expected after fall 2024.   

    Securities Of Interest to Non-US Persons UK Digital Assets

  • West Virginia updates its bank recordkeeping requirements to equate copies with originals

    State Issues

    On March 27, the Governor of West Virginia signed into law HB 4837, which amended the state’s general banking services code to permit banks to photographically or photo-statically reproduce its checks, documents, records, or other instruments (other than notes, securities, and investments) and use such photographic copies (e.g., scans) as substitutes for the originals. Under the law, the photographic copy would be deemed an original counterpart, having the same force and effect as the original, and would constitute admissible evidence in court. While the law would permit the bank to destroy the original copy, the bank must retain either the original or photographic reproductions of the documents for five years from the date of the last entry. Finally, the law would limit actions against any bank for “any balance, amount or proceeds from any time, savings or demand deposit account based on the contents of records” to a five-year retention period. This bill will go into effect after 90 days from passage: June 6.

    State Issues State Legislation Recordkeeping Securities

  • SEC Chair Gensler weighs in on AI risks and SEC’s positioning

    Privacy, Cyber Risk & Data Security

    On February 13, SEC Chair Gary Gensler delivered a speech, “AI, Finance, Movies, and the Law” before the Yale Law School. In his speech, Gensler spoke on the crossovers between artificial intelligence (AI) and finance, system-wide risks on a macro-scale, AI offering deception, AI washing, and hallucinations, among other topics.

    Gensler discussed the benefits of using AI in finance, including greater financial inclusion and efficiencies. However, he highlighted that the use of AI amplifies many issues, noting how AI models can be flawed in making decisions, propagating biases, and offering predictions. On a system-wide level, Gensler opined how policy decisions will require new thinking to overcome the challenges to financial stability that AI could create.  Gensler addressed AI washing, stating that it may violate securities laws, emphasizing that any disclosures regarding AI by SEC registrants should still follow the “basics of good securities lawyering” for disclosing material risks, defining the risk carefully, and avoiding disclosures that could mislead the public regarding the use of an AI model. Lastly, Gensler warned about AI hallucinations, saying that advisors or brokers are not supposed to give investment advice based on inaccurate information, closing with “You don’t want your broker or advisor recommending investments they hallucinated while on mushrooms.”

    Privacy, Cyber Risk & Data Security Artificial Intelligence Securities Exchange Act Securities AI

  • 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

  • Securities regulators issue guidance and an RFC on AI trading scams

    Financial Crimes

    On January 25, FINRA and the CFTC released advisory guidance on artificial intelligence (AI) fraud, with the latter putting out a formal request for comment. FINRA released an advisory titled “Artificial Intelligence (AI) and Investment Fraud” to make investors aware of the growing popularity of scammers committing investment fraud using AI and other emerging technologies, posting the popular scam tactics, and then offering protective steps. The CFTC released a customer advisory called “AI Won’t Turn Trading Bots into Money Machines,” which focused on trading platforms that claim AI-created algorithms can guarantee huge returns.

    Specifically in FINRA’s notice, the regulator stated that registration is a good indicator of sound investment advice, and offers the Investor.gov tool as a means to check; however, even registered firms and professionals can offer claims that sound too good to be true, so “be wary.” FINRA also warned about investing in companies involved in AI, often using catchy buzzwords or making claims to “guarantee huge gains.” Some companies may engage in pump-and-dump schemes where promoters “pump” up a stock price by spreading false information, then “dump” their own shares before the stock’s value drops. FINRA’s guidance additionally discussed the use of celebrity endorsements to promote an investment using social media; FINRA states that social media has become “more saturated with financial content than ever before” leading to the rise of “finfluencers.” Finally, FINRA mentioned how AI-enabled technology allows scammers to create “deepfake” videos and audio recordings to spread false information. Scammers have been using AI to impersonate a victim’s family members, a CEO announcing false news to manipulate a stock’s price, or how it can create realistic marketing materials.

    The CFTC’s advisory highlighted how scammers use AI to create algorithmic trading platforms using “bots” that automatically buy and sell. In one case cited by the CFTC, a scammer defrauded customers into selling him nearly 30,000 bitcoins, worth over $1.7 billion at the time. The CFTC posted a Request for Comment on the Use of Artificial Intelligence in CFTC-Regulated Markets. The Request listed eight questions addressing current and potential uses of AI by regulated entities, and several more addressing concerns regarding the use of AI in regulated markets and entities for the public to respond to.

    Financial Crimes FINRA Artificial Intelligence CFTC Securities Exchange Commission Fraud Securities

  • 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

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