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International bank and head trader settle with SEC for CMBS fraud
On February 12, the Securities Exchange Commission (SEC) announced that it reached an agreement with an international bank and its former head trader for allegedly selling commercial mortgage-backed securities (CMBS) to customers by using false and misleading statements. The bank has agreed to repay more than $3.7 million to the affected customers According to the order, the bank misled customers about the original purchase price of the CMBS and failed to institute proper compliance and surveillance procedures in order to detect and prevent the misconduct. Additionally, the order states that the bank’s former head trader failed to properly supervise the traders making the allegedly false statements and failed to take appropriate action when he became aware of the statements.
In addition to the customer repayment, the bank has agreed to pay a $750,000 civil money penalty to the SEC, while the former head trader has agreed to a $165,000 civil money penalty and a 12-month suspension from the securities industry. According to the SEC, the settlement amounts reflect substantial cooperation by both parties during the investigation and remedial efforts taken by the bank to improve surveillance and compliance controls. Both parties consented to the order without admitting or denying the findings.
SEC exams to focus on ICOs, cybersecurity, and AML programs
On February 7, the SEC’s Office of Compliance Inspections and Examinations (OCIE) released its 2018 Examination Priorities, which includes cryptocurrency and Initial Coin Offerings (ICOs) for the first time. According to the document, the OCIE’s 2018 priorities reflect “certain practices, products, and services that OCIE believes may present potentially heightened risk to investors and/or the integrity of the U.S. capital markets.” The document highlights five themes:
- Retail Investors. Among other retail investor priorities, OCIE states it will focus on high-risk products, including cryptocurrency and ICO markets due to their rapid growth. Exams in this area will review whether there are adequate controls and safeguards to protect against theft and whether appropriate disclosures about the risks associated with the investments are given to investors.
- Compliance and Risks in Critical Market Infrastructure. OCIE will look at important participants in the market structure, including clearing agencies, national securities exchanges, transfer agents, and entities under Regulation SCI.
- Review of Other Regulatory Bodies. OCIE intends to review the operations and controls of the Financial Industry Regulatory Authority (FINRA) and the Municipal Securities Rulemaking Board (MSRB).
- Cybersecurity. OCIE notes that the scope and severity of cybersecurity risks have increased dramatically. According to the document, examinations will continue to focus on, among other things, data loss prevention, governance and risk assessment, and vendor management.
- AML Programs. Anti-money laundering (AML) program examinations will focus on whether the regulated entities are “appropriately adapting their AML programs to address their obligations.” More specifically, OCIE will look at whether entities are filing accurate Suspicious Activity Reports (SARs) and performing appropriate customer due diligence reviews.
SEC halts allegedly fraudulent ICO
On January 30, the Securities and Exchange Commission (SEC) announced it obtained a court order preventing an allegedly fraudulent initial coin offering (ICO) by a Dallas-based company. According to the complaint filed on January 25, the company pitched its ICO by depicting itself as a “decentralized bank” that could automatically trade in multiple cryptocurrencies and provide a variety of consumer banking products and services based on over 700 different virtual currencies. The SEC alleges that the company failed to properly register the ICO and made materially false statements in its advertisements, such as: (i) the company’s purchase of an FDIC-insured bank; and (ii) the availability of a company-branded VISA card allowing for payment of goods and services using different virtual currencies held in a checking account with the company. The company also purportedly failed to disclose the criminal background of certain executives. According to the SEC, the District Court approved an emergency asset freeze and placed the company in receivership. Among other things, the SEC is seeking a permanent injunction and the release of profits associated with the fraudulent activity, plus interest and penalties.
CFTC reaches spoofing settlements with banks; joint investigation with DOJ leads to civil and criminal charges against traders
On January 29, three global banks agreed to pay a combined $46.6 million fine to settle civil allegations by the Commodity Futures Trading Commission (CFTC) that their traders engaged in a practice known as spoofing to manipulate futures markets, which involves placing bids or offers with the intent to cancel before execution. While neither admitting nor denying any wrongdoing in connection with the settlements, the banks agreed, among other things, to pay the fines, maintain controls in order to detect and prevent spoofing among traders, and implement new training programs. As part of a larger investigation conducted by the CFTC and the criminal divisions at the DOJ and FBI, the CFTC stated within the same announcement that civil enforcement actions were filed against six individuals for alleged spoofing violations. Additionally, according to a press release issued the same day, the DOJ announced criminal charges against eight individuals who allegedly participated in various deceptive trading practices, including the six traders named in the CFTC’s civil complaints. The DOJ alleged the defendants’ spoofing trades were designed to defraud individuals and entities by artificially depressing or inflating the prices of futures contracts traded on several exchanges.
FINRA releases 2018 regulatory and examinations priorities letter
On January 8, the Financial Industry Regulatory Authority (FINRA) published its Annual Regulatory and Examination Priorities Letter (2018 Letter), which focused on several broad issues within the securities industry, including improving the examination program to “implement a risk-based framework designed to better align examination resources to the risk profile of [] member firms.” As previously covered in InfoBytes, last July FINRA360 (a comprehensive self-evaluation and organizational improvement initiative) prompted the organization to announce plans currently underway to enhance operations by consolidating its existing enforcement teams into a single unit. In the 2018 Letter, FINRA announced ongoing efforts to work with member firms to understand the risks and benefits of fintech innovation such as blockchain technology, as well as the impact initial coin offerings (ICOs) and digital currencies have on broker-dealers.
Additional areas of regulatory and examination focus for FINRA in 2018 will include: (i) fraudulent activities and suspicious activity report filing requirements; (ii) business continuity planning; (iii) protection and verification of customer assets, including whether firms have implemented adequate controls and supervision methods along with measuring the effectiveness of cybersecurity programs; (iv) anti-money laundering monitoring and surveillance resources and policies and procedures; and (v) the role firms and other registered representatives play when effecting transactions in cryptocurrencies and ICOs—specifically with regard to the supervisory, compliance and operational infrastructure firms implement to “ensure compliance with relevant federal securities laws and regulations and FINRA rules.”
FINRA Fines Brokerage Firm $2.8 Million for Customer Protection Rule Violations
On December 27, the Financial Industry Regulatory Authority (FINRA) announced that it fined a New York-based brokerage firm $2.8 million based on allegations that the firm violated the SEC’s Customer Protection Rule and due to other related supervisory failures. According to the Letter of Acceptance, Waiver, and Consent (AWC), from March 2008 to June 2016, the firm did not have reasonable processes in place to ensure that its control systems were operating properly. As a result of these design flaws, the firm failed to properly segregate customers’ foreign and domestic securities in appropriate control locations, leading to deficits in securities valued at hundreds of millions of dollars.” The firm neither admitted nor denied the findings set forth in the AWC agreement.
SEC Obtains Emergency Court Order Against Canadian Firm for Allegedly Violating Federal Securities Law; Halts Initial Coin Offering
On December 4, the SEC announced it had obtained an emergency court order to freeze the assets of a Canadian company and the company’s founders (Defendants) and block Defendants’ ability to continue to raise funds through an initial coin offering (ICO). At the time the order was issued, the ICO had raised $15 million since August by “promising investors returns of 1,354% in under 29 days.” This is the first enforcement action taken by the SEC’s recently established Cyber Unit, whose focus includes distributed ledger technology and initial coin offering violations. (See previous InfoBytes Cyber Unit coverage here.)
According to a complaint filed December 1 in the U.S. District Court for the Eastern District of New York, Defendants allegedly violated the anti-fraud and registration provisions of U.S. federal securities laws by making a series of materially false and misleading statements when marketing and selling securities as digital tokens/cryptocurrencies to obtain investor funds. From August to the present, Defendants purportedly raised $15 million through the ICO, and made false representations including, among other things, that: (i) the firm consisted of large teams of experts across the globe, and (ii) investors would receive certain promised returns (1,354% in less than a month) on investments if all tokens were sold. Further, Defendants allegedly failed to disclose (i) that a portion of the proceeds from the ICO funds would pay personal expenses, and (ii) that the company’s principal executive was “a known recidivist securities law violator in Canada.” The SEC seeks relief in the form of permanent injunctions, monetary penalties and interest, and an “officer-and-director bar and a bar from offering digital securities” against the company’s founders.
SEC Reaches $3.5 Million Settlement With Broker-Dealer Over Failure to File Suspicious Activity Reports
On November 13, the SEC announced it has reached a settlement in an administrative proceeding against a broker-dealer firm for allegedly willful violations of Section 17(a) of the Securities and Exchange Act, including the firm’s failure to file, or timely file, at least 50 Suspicious Activity Reports (SARs) with the Financial Crime Enforcement Network (FinCEN) from approximately March 2012 through June 2013. As the SEC Order notes, Bank Secrecy Act regulations require a broker-dealer to file a SAR if it knows, suspects or has reason to suspect that a transaction of a certain minimum or aggregated amount involved funds derived from illegal activity or if the transaction was conducted to disguise funds derived from illegal activities. Other factors requiring a broker-dealer to file a SAR include the absence of any business or apparent lawful purpose for the transaction or if the transaction is to facilitate criminal activity.
When deciding whether to accept the firm’s settlement offer, the SEC considered voluntary remedial efforts undertaken by the firm, including the fact that the firm retained a third-party anti-money laundering (AML) compliance company to conduct a review of some of the firm’s SAR investigations. Under the terms of the settlement, the firm voluntarily agreed to, among other things, conduct a review of its AML policies and procedures for the identification, evaluation and reporting of suspicious activity related to firm accounts; and provide additional training to staff responsible for conducting investigations and filing SARs. Additionally, the firm was assessed a civil money penalty of $3.5 million.
SEC Chairman Discusses Corporate Governance, States Enhanced Transparency Can Help Prevent Fraud, and Reveals First-Ever National Database of Barred Brokers and Advisors
On November 8, the Chairman of the SEC, Jay Clayton, spoke before the Practising Law Institute’s annual institute on securities regulation to discuss the role of corporate governance and how enhanced transparency can help prevent fraud. Clayton stated that the SEC would be streamlining and shortening its near-term agenda in an effort to increase transparency and accountability, and that the SEC also would apply this approach to its longer-term strategic plans as well.
Clayton also commented on approaches to mitigate “misconduct” before an enforcement action would be required. Specifically, Clayton noted, “[l]ooking back at enforcement actions, a common theme emerges – where opacity exists, bad behavior tends to follow.” Clayton highlighted the following areas in which opacity may exist: (i) disclosures involving “hidden or inappropriate fees”; (ii) poor recordkeeping and lack of reliable information related to penny stocks; (iii) transaction processing related to unregistered securities; (iv) online platforms that manage initial coin offerings (ICOs); and (v) investor education.
Concerning ICOs, Clayton commented that because “[t]here is a distinct lack of information about many online platforms that list and trade virtual coins or tokens offered and sold in . . . ICOs . . ., [t]rading of tokens on these platforms is susceptible to price manipulation and other fraudulent trading practices.” The SEC proposed enhanced clarity when listing tokens on these types of platforms, assigning value to tokens, and examining measures designed to protect investors and market integrity.
Clayton further revealed that the SEC was creating a website that would publish, among other things, a searchable database of those individuals who have been barred or suspended as a result of federal securities law violations. Clayton noted that this database would be “intended to make the prior actions of repeat offenders and fraudsters more visible to investors” and could be “particularly valuable when bad actors have shifted from the registered space for investment advisers and broker-dealers to the unregistered space.”
CFTC Issues Primer on Virtual Currencies, Claims Certain Virtual Tokens Fall Under Its Oversight
On October 17, the U.S. Commodity Futures Trading Commission (CFTC) announced the release of “A CFTC Primer on Virtual Currencies” (Primer) issued by its LabCFTC division. As previously discussed in Infobytes, the LabCFTC initiative rolled out in May of this year to engage innovators in the financial technology industry to promote responsible fintech innovation within regulated CFTC markets. In this Primer—a first in a series—the CFTC discusses potential use-cases for virtual currencies and outlines the agency’s role and oversight of virtual currencies. The Primer also highlights the risks associated with virtual currencies, such as (i) the susceptibility of “digital wallets” to cybersecurity hacks; (ii) inadequate safeguards and other customer protection related systems on virtual currency exchanges; and (iii) the susceptibility of virtual currencies to Ponzi schemes and other types of frauds.
The CFTC noted that there’s no inconsistency between the SEC’s analysis that Initial Coin Offerings or Token Sales may be subject to federal securities law (see previous InfoBytes coverage here) and CFTC’s determination that virtual currencies are commodities and virtual tokens “may be commodities or derivatives contracts, depending on the particular facts and circumstances.” Last month, as discussed in InfoBytes, the CFTC also filed its first-ever antifraud enforcement action for activities involving Bitcoin investment solicitations.