by T. GormanPosted on Posted in SECActions

Complex exchange traded products were one of the key agenda items for the Commission last week. New products were recently approved. Nevertheless, three Commissioners expressed concern about the complexity of the products, the adequacy of the disclosure and the use of the products by many investors, all points previously discussed here. Where all this leads has yet to be determined.

SEC

Remarks: Gruber Grenwal, Director, Division of Enforcement delivered remarks at the recent PLI Conference. His comments focused on effective compliance, cooperation and meaningful penalties (here).

Be careful, be safe this week

SEC Enforcement – Filed and Settled Actions

Last week the Commission filed 4 civil injunctive actions and no administrative proceedings, exclusive of tag-along and other similar proceedings.

Offering fraud: SEC v. Pagartanis, Civil Action No. 25242 (October 7, 2021) is a previously filed action which names as defendant Steven Pagartanis. While employed as an investment professional, Defendant sold investments to the public based on a series of false statements. He also misappropriated investor funds. In a parallel criminal action Mr. Pagartanis pleaded guilty to one count of conspiracy to commit mail and wire fraud. He was sentenced to serve 120 months in prison followed by three years of supervised release. He was also directed to pay restitution of $6,519,594. In the Commission’s action Defendant consented to the entry of, and the Court entered, a final judgement which enjoins him from future violations of Securities Act Section 17(a) and Exchange Act Section 10(b). The judgment also orders him to pay disgorgement in the amount of $6,519,594 which is deemed satisfied by the restitution order in the criminal case. See Lit. Rel. No. 25242 (October 7, 2021).

Offering fraud: SEC v. CanaFarma Hemp Products Corp., Civil Action No. 21 Civ. 8211 (S.D.N.Y. Filed October 5, 2021) names as defendants the firm, alleged to be an integrated hemp company, Vitaly Fargesen, a co-founder of the firm, and Igor Palatnik, also a co-founder of the firm. Beginning in April 2019, and continuing until October 2020, Defendants sought investors for CanaFarma. The firm was touted as an integrated hemp firm that made various products and had its own farms. The claims were false – the company did not own farms, was not integrated and its financial projections were wrong. About $15 million was raised from over 60 investors. Approximately $4 million was misappropriated. The complaint alleges violations of Securities Act Section 17(a) and Exchange Act Section 10(b). The case is pending.

Offering fraud: SEC v. Harrison, Civil Action No. 8:21-01610 (C.D. Ca. Filed September 30, 2021) is an action which names as defendants Ron K. Harrison and Global Trading Institute, LLC. Beginning in 2016, and continuing through August 2021, Mr. Harrison and his firm acted as unregistered investment advisers. During the period Defendants ran up over $2 million in losses for clients while collecting fees of over $900,000. Clients were not told about the losses or the fact that Mr. Harrison was previously barred from the securities business by FINRA as he touted his expertise. The complaint alleges violations of Securities Act Section 17(a), Exchange Act Section 10(b) and Advisers Act Sections 206(1) and 206(2). The Commission obtained an emergency freeze order. The case is pending. See Lit. Rel. No. 25241 (October 6, 2021).

Manipulation: SEC v. Melnick, Civil Action No. 1:21-cv-04054 (N.D. Ga. Filed September 30, 2021) is an action which names as a defendant Mark J. Melnick, the host of a subscription real time radio program. Beginning in January 2018, and continuing for two years, he manipulated the share price of numerous stocks and options. Specifically, Mr. Melnick received notice from Trader A when certain public companies were about to be the subject of false rumors. Mr. Melnick assisted in disseminating the rumors by announcing on his radio show that the firms involved were subject to “chatter.” He then traded in the shares of those firms. Over the period he traded in the shares of about 100 firms, reaping about $374,835 in profits. The complaint alleges violations of Securities Act Section 17(a) and Exchange Act Section 10(b). The case is pending.

False statements: SEC v Roberts, Civil Action No. 21-cv-1615 (C.D. Ca. Filed September 30, 2021) is an action which names as defendant: Richard Roberts, the CEO of Defendant TCFG Investment Advisors, LLC, a registered investment adviser and controls the holding company that owns registered broker-dealer TCFG Wealth Management, LLC. Over a six-year period, beginning in 2014, Defendant Roberts and his advisory firm falsely stated to advisory clients that the affiliated broker dealer, TCFG, “may” be receiving portions of the fees charged to advisory accounts by its third party clearing and custody firm. In fact, the fees were being charged and passed on to advisory clients about 60% of the time. The complaint alleges violations of Advisers Act Sections 206(1), 206(2), and 206(4). The case is pending.

Criminal cases

Offering fraud: U.S. v. Borland, No. 18-cr-00487 (S.D.N.Y. October 5, 2021) is an action in which Brent Borland, the owner of a New York based investment fund – the Belize Infrastructure Fund I – was sentenced to serve 84 months in prison after pleading guilty. The charges were based on a four year scheme that began in 2014. Defendant solicited investors to acquire interests in the fund. The money was to be used for infrastructure development in Belize. High rates of return were promised. About $26 million was raised from about 40 investors. In fact, much of the money was misappropriated. Mr. Borland pleaded guilty to conspiring to commit, and the commission of, securities fraud and wire fraud.

Hong Kong

Survey: The Securities and Futures Commission and the Hong Kong Monetary Authority announced their findings from the first joint survey on the sale of non-exchange traded investment products by licensed corporations and registered institutions on October 7, 2021 (here).

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by T. GormanPosted on Posted in SECActions

Earlier this month the Commission approved two new complex financial products. Despite the approval, the new products sparked comments from Chair Gensler (here) and, in a separate but joint statement, Commissioners Allison Herren Lee and Caroline A. Crenshaw (here). While each of the Commissioners reaffirmed the decision to approve the products, each expressed concern about investor use of complex products. The comments also follow recent enforcement actions where brokers with inadequate training and/or information recommended complex products to investors who appear to have been ill-prepared at best to utilize them. See, e.g., In the Matter of American Financial Services, Inc., Adm. Proc. File No. 3-20151 (Nov. 13, 2020)(settled action based on on IPath S&P 500 VIX Short-term Futures ETN or VXX).

Chair Gensler essentially cautioned investors about the use of complex products such as those recently approved. Products such as leveraged ETFs and inverse ETFs, for example, are more complex than “typical stocks and bonds” the Chair noted. In other instances, the Office of Investor Protection, such as in 2009, highlighted the fact that a product should not be held for longer than one day – the situation presented with a complex product in the American Financial case cited above. More recently Chair Clayton expressed concern that ETPs “may present investor protection issues – particularly for retail investors who may not fully appreciate the particular characteristics or risks of such investments.” (Internal quotations omitted). All of this suggests that investors need to be cautious about the use of such products.

Commissioners Lee and Crenshaw concur with the Chair’s concerns but went further in their comments. The two Commissioners advocated a three-part approach to the situation. First, there should be a “strong, consistent regulatory oversight of all complex exchange-traded products,” according to the Commissioners. There may be significant differences among the various products. Some exchange traded products, for example, are registered investment companies. Others are registered only under the 1933 Securities Act and are not subject to the same requirements as those governed by the Investment Company Act. Nevertheless, the products may have similar objectives but different structures. These might include exchange traded notes, commodity pools, and structure notes, many of which refer to themselves as funds although they are not. The point is that the Commission “should endeavor to adopt a consistent approach to managing such risks [presented by these products] to ensure that our rules do not needlessly create opportunities for regulatory arbitrage.”

Second, the agency must adopt a “consistent, holistic approach to the review of exchange-traded products.” This approach must address the various risks posed by the products. Finally, it is critical that the approach adopted be based on heightened protections for investors trading these products.

All of the comments highlight the fact that trading the variety of complex financial products available today presents significant risks and the potential for huge losses by average investors even if the three step process advocated by Commissioner’s Lee and Crenshaw is adopted. While building investor protections based on the risks posed by the complex products is a worthy goal, the ultimate question is if it is sufficient. The federal securities laws are built on the idea that full disclosure of the facts is sufficient. There is no doubt that in many instances it is. In many instances, however, the products are complex to the point of being opaque. In many instances the warnings issued with the products, while well intended, in probability do little to aid the typical investor or even many financial professionals. Under these circumstances it may be appropriate to consider a second question – is disclosure sufficient? Stated differently, if the product is so opaque, is it actually a financial investment product at all or has it crossed the line and become something else? If investor protection is the goal, perhaps this question should be asked before new products are authorized when appropriate modifications can be made.

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