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SEC Chairman Outlines Regulatory Agenda
On July 12, SEC Chairman Jay Clayton spoke at the nonpartisan Economic Club of New York about the principles behind his regulatory agenda. In addition to outlining the SEC’s three-part mission on investor protection, market order and efficiency, and capital formation, Clayton stressed the need for cooperation with domestic and foreign regulators to ensure effective, sound regulatory approaches. Noting the SEC’s coordination with the Commodity Futures Trading Commission (CFTC) on issues concerning cybersecurity and swap markets specifically, Clayton highlighted plans to continue to work with the CFTC, under the guidance of Title VII of the Dodd-Frank Act, to “reduce unnecessary complexity as well as costs to both regulators and market participants.” The SEC also plans to continue to encourage strong enforcement and examination programs.
Enforcement Actions Announced by CFTC for Fraud, Registration Violations in Florida
On July 11, the CFTC announced that the U.S. District Court for the Middle District of Florida entered an order for final judgment by default against two individuals and their company for fraudulently soliciting investors in a commodity pool, misappropriating pool participants’ funds, and committing futures fraud, among other things. According to the CFTC complaint filed on January 26 of 2017, the defendants fraudulently marketed their company to prospective participants, materially misrepresented their past trading success using fabricated high rates of return, provided account statements to investors showing fictitious increases in value, and failed to disclose defendant’s previous permanent injunction on trading.
In addition to imposing a permanent injunction on trading and registration, the Court ordered defendants to pay civil monetary penalties of almost $1.85 million as well as restitution of $459,613. An appointed monitor will oversee the defendants’ payment of restitution. The Court also required one of the defendants to affirmatively disclose his violations in any future marketing materials, presentations, speeches or websites. The required disclosure names his violations, the amount of restitution and civil penalties he must pay, along with the case numbers of his CFTC actions.
Both of the defendants recently pleaded guilty to related criminal charges. One defendant was sentenced to one year and one day in prison in connection with her guilty plea to one count of obstruction of justice, and the other defendant is awaiting sentencing in connection with his guilty plea to one count of wire fraud.
International Bank Settles RMBS Claims with FHFA for $5.5 Billion
On July 12, the Federal Housing Finance Agency (FHFA), as conservator of Fannie Mae and Freddie Mac (GSEs), announced a $5.5 billion settlement with an international bank. The settlement resolves FHFA’s claims, lodged in a federal lawsuit in the District of Connecticut, that the bank violated federal and state securities laws in relation to residential mortgage-backed securities (RMBS) trusts purchased by the GSEs between 2005 and 2007. The settlement covers all RMBS “issued, sponsored, sold, or underwritten by . . . [d]efendant between January 1, 2004 and December 31, 2008,” which is intended to include all securities for which FHFA brought claims against the bank in the District of Connecticut action. Under the terms of the agreement, the bank will pay $4.525 billion of the settlement amount to Freddie Mac, and approximately $975 million to Fannie Mae.
FINRA Fines Financial Firms $2.4 Million for Improper Customer Records Storage
On July 5, the Financial Industry Regulatory Authority (FINRA) announced that several investment firms agreed to pay fines totaling $2.4 million for allegedly failing to maintain customer records in an electronic format that cannot be altered or destroyed. The firms all signed FINRA’s letters of Acceptance, Waiver, and Consent (AWC) containing allegations and proposed settlement terms for the alleged violations. See agreements here, here, and here.
In the agreements, FINRA emphasizes that financial firms are storing more and more sensitive customer data. FINRA asserts that broker-dealer electronic records must be complete and accurate to assist FINRA and other regulators in examinations and to ensure that member firms can conduct audits. Increasingly aggressive hacking attempts also enhance the need for firms to keep these records in the required format. According to the allegations in the agreements, the firms violated Section 17(a) of the Exchange Act of 1934 (the "Exchange Act"), NASD Rule 3110 and FINRA Rule 4511 by not maintaining electronic brokerage records in non-erasable and nonrewritable format, known as “WORM” format. The electronic records contained information about millions of securities transactions, millions of customer account records, numerous financial records, and records regarding anti-money laundering compliance.
FINRA also asserts that the firms: (i) failed to give 90-day advance notice to FINRA before storing records electronically; (ii) failed to set up audit systems for retaining records electronically; (iii) failed to obtain attestation letters from vendors agreeing to provide all firm records to regulators, if needed; and (iv) failed to set up and enforce written procedures to ensure electronically stored records were retained in compliance with FINRA and federal securities laws.
In addition to monetary sanctions, the firms agreed to review and update policies and procedures to ensure compliance with FINRA and federal securities laws. Additionally, the firms must submit remediation plans to FINRA for approval.
CFTC Enters into First-Ever Non-Prosecution Deals in Spoofing Investigation
On June 29, the Commodity Futures Trading Commission (CFTC) entered into non-prosecution agreements with three futures traders who admitted to engaging in “spoofing” in the U.S. Treasury futures market between 2011 and 2012 (see non-prosecution agreements here, here, and here). Spoofing involves placing bids or offers with the intent to cancel before execution. Here, the traders placed a small bid or offer on one side of the market and a large bid or offer on the opposite side of the market to be cancelled almost immediately (often in less than one second). The traders used the strategy to get smaller orders filled (and filled more quickly) at favorable prices.
This is the first time the CFTC has used non-prosecution agreements, which the Director of Enforcement called “a powerful tool to reward extraordinary cooperation in the right cases, while providing individual and organizations strong incentives to promptly accept responsibility for their wrong doing and cooperate with the Division’s investigation.” In announcing the agreements, the CFTC lauded the traders’ “timely and substantial cooperation,” noting that their efforts provided assistance in connection with a $25 million settlement with the multinational bank they worked for earlier this year.
FTC Announces Settlement with Operators of Tech Support Scam
On June 7, the FTC announced two settlements in a pending action brought against defendants who allegedly used pop-up internet ads to deceive consumers into believing their computers were infected and then sold unnecessary technical support services to fix the issues. Under the terms of the settlements (available here and here), the defendants (i) will relinquish assets combined at nearly $6 million to provide restitution to victims, and (ii) are banned from marketing, promoting, or misrepresenting technical support products or services in the future. The settlement is part of the FTC’s ongoing efforts to pursue tech support scams through its Operation Tech Trap initiative. (See previous InfoBytes coverage here.)
FINRA Announces Fintech Outreach Initiative, Hosts Blockchain Symposium in July
On June 13, the Financial Industry Regulatory Authority (FINRA) announced a new outreach initiative to improve its understanding of fintech innovations and how they impact the securities industry. The Innovation Outreach Initiative will consist of the following components:
- the launch of FINRA’s new webpage dedicated to fintech topics such as RegTech (covering compliance monitoring, fraud prevention, data management, and the identification and interpretation of regulations affecting the securities industry), artificial intelligence, and social media sentiment investing; and
- the creation of a cross-departmental team led by the Office of Emerging Regulatory Issues developed to, among other things, foster discussion on fintech developments, develop publications on fintech topics, and increase collaboration with domestic and international regulators.
Additionally, FINRA announced it will host a Blockchain Symposium in New York City on July 13 to create an opportunity for regulators and industry leaders to join together and discuss opportunities and challenges related to the use of Distributed Ledger Technology, also known as blockchain.
Charges Filed by SEC Allege Bank Secrecy Act Violations
On June 5, the SEC filed charges against a U.S. brokerage firm (firm) for failure to comply with suspicious activity reports (SARs) filing requirements, in violation of the Bank Secrecy Act (BSA), the Exchange Act Section 17(a), and Rule 17a-8. The complaint, filed in the U.S. District Court for the Southern District of New York, alleges that although the firm had a BSA Compliance Program, the program did not accurately reflect what the firm did in practice. More specifically, the SEC alleges thousands of violations including failure to file SARs, failure to file SARs within the required 30 days after the date the suspicious activity was detected, and filing incomplete SARs that did not include the requisite narratives describing what is “unusual, irregular, or suspicious” about the transaction. According to the SEC press release, “by failing to file SARs, [the firm] deprived regulators and law enforcement of critically important information often related to trades in microcap securities used to investigate potentially serious misconduct.”
The SEC requested relief in the form of permanent injunctions and monetary penalties and interest.
Attorney General Sessions Issues Memorandum Ending Payments to Third-Party Organizations as Part of Future Settlement Agreements
On June 7, Attorney General Jeff Sessions issued a memorandum entitled “Prohibition on Settlement Payments to Third Parties” instructing the Department of Justice (DOJ) to cease entering into settlement agreements that include payments to third-party organizations. Attorney General Sessions stated in a press release released by the DOJ, “[w]hen the federal government settles a case against a corporate wrongdoer, any settlement funds should go first to the victims and then to the American people—not to bankroll third-party special interest groups or the political friends of whoever is in power.”
Summary of Memorandum. The memorandum, which became effective immediately and applies to future settlements, notes that previous settlement agreements involving the DOJ required “payments to various non-governmental, third-party organizations . . . [that] were neither victims nor parties to the lawsuits.” The memorandum now states that DOJ “attorneys may not enter into any agreement on behalf of the United States in settlement of federal claims or charges . . . that directs or provides for a payment or loan to any non-governmental person or entity that is not a party to the dispute.” The following are “limited” exceptions:
- “the policy does not apply to an otherwise lawful payment or loan that provides restitution to a victim or that otherwise directly remedies the harm that is sought to be redressed, including, for example, harm to the environment or from official corruption”;
- “the policy does not apply to payments for legal or other professional services rendered in connection with the case”; and
- “the policy does not apply to payments expressly authorized by statute, including restitution and forfeiture.”
The memorandum states that it applies to “all civil and criminal cases litigated under the direction of the Attorney General and includes civil settlement agreements, cy pres agreements or provisions, plea agreements, non-prosecution agreements, and deferred prosecution agreements.”
Supreme Court Rules Five-Year Statute of Limitations Applies to SEC Civil Penalties
In a unanimous ruling handed down on June 5, the United States Supreme Court held that the SEC is bound by a five-year statute of limitations on civil penalties or the return of illegal profits, citing 28 U.S.C. §2462 of the U.S. Code, which “establishes a [five-year] limitations period for ‘an action, suit or proceeding for the enforcement of any civil fine, penalty, or forfeiture.’” Justice Sotomayor delivered the opinion.
The decision resolves a New Mexico case dating back to 2009, in which a jury found the defendant liable for misappropriating more than $34.9 million from 1995 through July 2007 from four SEC-registered investment companies under his control. See S.E.C. v. Kokesh, 834 F.3d 1158 (10th Cir. 2016). The district court judge ordered the defendant to pay a $2.4 million civil penalty, nearly $35 million in disgorgement, and more than $18 million in prejudgment interest after finding that §2462 did not apply because “disgorgement” is not a penalty within the meaning of the statute. The defendant appealed the ruling on the grounds that the disgorgement should be set aside because the claims accrued more than five years before the SEC brought its action against him and are consequently barred under the five-year statute of limitations. However, the 10th Circuit affirmed the ruling of the lower court, agreeing that disgorgement was not a penalty.
The Supreme Court reversed. Justice Sotomayor explained why the Court disagreed with the 10th Circuit panel’s conclusion that disgorgement was not a penalty under the statute. The Court held that disgorgement “bears all the hallmarks of a penalty” and “is imposed as a consequence of violating a public law and . . . is intended to deter, not to compensate.” Consequently, disgorgement represents a penalty, thus falling within the five-year statute of limitations of §2462.