by T. GormanPosted on Posted in SECActions

Last week as everyone celebrated the Thanksgiving holiday, the Commission continued to schedule meetings regarding proposed rule revisions. The rules to be considered involve select offerings tied to compensation.

The Enforcement Division filed two new actions in advance of the holiday.

Be safe and healthy this week

SEC

Proposed rules: The Commission proposed on November 24, 2020 to modify Rule 701 and Form S-8 regarding compensatory securities offerings in view of the evolving market. Specifically, the proposal seeks to exempt transactions over $10 million, revise the disclosures and raise two of the three caps. There are also proposals related to Form S-8 and to simplify counting and fee payments (here).

Proposed rules: The agency proposed to adopt certain temporary rules to facilitate participation for “platform workers” in compensation offerings under Rule 701 and Form S-8, on November 24, 2020 (here). The proposal would permit issuers to provide equity compensation to certain platform workers who provide services available through the issuer’s technology based platform or system.

Statement: Commissioners Hester M. Peirce and Elad L. Roisman filed statements on November 24, 2020 suggesting an additional expansion of the revisions in view of the development of the gig economy (here). The statement was issued on November 24, 2020.

Statement: Commissioners Allison Herren Lee and Caroline A. Crenshaw issued a statement regarding the modifications to Rule 701 and Form S-8 in view of the gig economy. Essentially, they argued that the data used to support the amendments is much broader than what was used in connection with the modifications (here).

SEC Enforcement – Filed and Settled Actions

The Commission filed 2 civil injunctive actions and no administrative proceedings last week, excluding 12j, tag-along proceedings and other similar matters.

Conflicts/misrepresentations: SEC v. Rumbaugh, Civil Action No. 5:19-cv-01517 (CD Cal.) is a previously filed action which named as defendants Craig Rumbaugh and his two controlled entities, one of which is a state registered investment adviser. The action centers on the recommendation of the adviser to clients that they invest in a firm which supposedly would place the money in short term, high interest notes. In fact, the eight clients who put in over $3 million later learned that the entity was a Ponzi scheme. In addition, Defendants received over $140,000 in concealed commissions. Defendants also made misrepresentations regarding the claimed investments. To resolve the action each Defendant consented to the entry of a permanent injunction based on Securities Act Sections 5(a), 5(c) and 17(a), Exchange Act Sections 10(b) and 15(a) and Advisers Act Sections 206(1) and 206(2). Defendants also agreed to pay, on a joint and several basis, disgorgement in the amount of $676, 000, prejudgment interest of $137,808 and a penalty of $192,768. In a related administrative proceeding Mr. Rumbaugh consented to the entry of an order which bars him from the brokerage business. See Lit. Rel. No. 24969 (Nov. 24, 2020).

Offering fraud: SEC v. Benja Inc., Civil Action No. 3:20-cv-8328 (N.D. Cal. Filed Nov. 23 2020) is an action which names as defendants the firm, supposedly an on-line marketer, and its CEO Andrew J. Chapin. Defendants raised several million dollars from investors and banks by representing that Benja had contracts with major vendors such as Nike, Patagonia and Franatics, all of which helped make the firm profitable. In reality the firm had no contracts and was not profitable. The complaint alleges violations of each subsection of Securities Act Section 17(a) and Exchange Act Section 10(b). The complaint is pending. See Lit. Rel. No. 24968 (Nov. 23, 2020).

Insider trading: SEC v. Sullivan, Civil Action No. 2:20-cv-811 (W.D. Pa. Filed Nov. 20, 2020) is an action which names as a defendant Michael Sullivan, an employee at a publicly traded sporting goods store chain. In two instances when Mr. Sullivan was subject to blackout periods, he engaged in insider trading, purchasing options in advance of an earnings announcement. The first instance was in advance of the announcement for the second financial quarter of 2018. Defendant purchased 100 put options. Following the announcement of results the share price declined 9%. Mr. Sullivan had profits of $11,500. The second centered on the results for the third quarter of 2019. In advance of the announcement of the results Mr. Sullivan purchased 132 call options. In this instance the share price increased over 18%. Mr. Sullivan had trading profits of over $26,000. The complaint alleges violations of Exchange Act Section 10(b). The case is pending. See Lit. Rel. No. 24967 (Nov. 23, 2020).

Offering fraud: SEC v. Winston Reed Investments, LLC, Civil Action No. 1:20-cv-38 (W.D.N.C.) is a previously filed action which named as defendants Mark N. Pyatt and his firm, Winston Reed Investments. Defendants raised millions of dollars by representing to investors that they would employ the funds in a sophisticated strategy employing futures contracts. In fact, most of the funds were misappropriated. To resolve the matter each Defendant consented to the entry of a permanent injunction based on Securities Act Section 17(a) and Exchange Act Section 10(b). Defendants also agreed to pay, on a joint and several basis, disgorgement of $255,850 subject to offset by the amount paid as restitution in a parallel criminal against Mr. Pyatt. In the criminal case Mr. Pyatt pleaded guilty to one count of wire fraud and was sentenced to serve 37 months in prison followed by three years of supervised release. See Lit. Rel. No. 24966 (Nov. 20, 2020).

Hong Kong

Consultation: The Securities and Futures Commission concluded a consultation on changes to the REIT Code, according to an announcement made on November 27, 2020 (here). The changes are designed to permit the Hong Kong REIT market to facilitate long term growth while enduring investor protection.

Singapore

Remarks: Ravi Menon, Managing Director of the Monetary Authority of Singapore, delivered remarks titled “growing Timber” at the MAS-IBF Webinar on November 26, 2020 (here). His remarks focused on job opportunities and readiness in the coming market.

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by T. GormanPosted on Posted in SECActions

Data analytics has evolved into a key tool of the SEC’s enforcement program. The most recent example of this is a series of settled administrative proceedings centered on the use of Exchange Traded Products. The products are complex. The theory, however, is detailed in the prospectus issued with each product. Understanding it takes time and study. Unfortunately neither the market professionals nor their clients in the Commission’s actions seem to have put in the study. The results were predictable: losses for the investors.

Typical of these proceedings is In the Matter of American Financial Services, Inc., Adm. Proc. File No. 3-20151 (Nov. 13, 2020). Respondents in this proceeding are American Financial or APFS and American Portfolios Advisors, Inc. or APA, respectively, a registered broker dealer and an investment adviser. The Exchange Traded Product involved is iPath S&P 500 VIX Short-Term Futures ETN or VXX.

VXX is traded on the NYSE Arca, Inc. It is a volatility-linked, complex exchange traded note which “offers exposure to futures contracts” of specific maturities on the VIX — the CBOE. The VIX tries to track the expected volatility of the S&P 500 but not its price level. The performance of VXX is not directly linked to the VIX. It is linked to a separate Index that tracks the price of futures contracts on the exchange. That Index is based on a “rolling portfolio of one-month and two-month futures contracts to target a constant weighted average of one-month maturity.” To do this each day the Index sells futures contracts that are the closest to the expiration and buys the next month out.

The VXX prospectus made it clear that that historically the exchange was in contango – the farther out contracts priced higher than those of the near-term contracts. When the market is in backwardation the reverse is true. Since the exchange is typically in contango, a significant cost is incurred over time from the daily roll of the futures contracts.

At times the VIX performance may vary from that of the Index and may have a positive performance during periods when the Index experiences poor performance. On the other hand, the VXX may experience a significant decline over time. In those instances, the risk increases the longer the VXX is held. In the end, however, the VXX has a limited upside potential, according to the prospectus, because over the longer term it usually reverts to a historical mean and its absolute level has been constrained within a band.

Registered representatives began early in 2016 to recommend investors buy and hold the VXX as a part of their overall portfolio. At the time there was a fear that political and other events would cause the market to drop. Many of the clients followed the advice, purchased the VXX and held it for over a year.

The VXX was viewed as a kind of hedge that would guard against the feared price drop. In making those recommendations the registered representatives failed to understand that the investments were not suitable for use as a short term hedge. Yet customers were told the opposite — buy and hold for the long term to protect against downward market risk. No mention was made of what is effectively a monthly reset and the resulting costs incurred in each instance.

The firms did have policies and procedures regarding complex products. Those policies and procedures mandated that representatives understand the products prior to making a recommended. The policies and procedures were ineffective in preventing the losses incurred by customers here because they were not properly implemented. Supervisory failure also facilitated the client losses. The Order alleges violations of Exchange Act Section 15(b)(4)(E) and Advisers Act Section 206(4) and Rule 206(4)-7.

To resolve the matter Respondents implemented certain remedial efforts. Respondent APA consented to the entry of a cease-and-desist order based on the Advisers Act Section and Rule cited in the Order. APFS consented to the entry of a cease-and-desist order based on the Exchange Act section cited in the Order. The two firms were censured and will also pay, jointly and severally, a civil monetary penalty of $650,000. A fair fund will be created for the portion of the losses tied to the product.

The Commission filed four similar cases at the same time this action was initiated. See In the Matter of Benjamin F. Edwards & Co., Inc., Adm. Proc. File No. 3-20153 (Nov. 13, 2020)(action tied to same product; settled with a series of remedial efforts, a consent to the entry of a cease and desist order based on the same Advisers Act Section and Rule, a censure and the payment of disgorgement of $31,417.62, prejudgment interest of $3,716.74 and a penalty of $650,000; $685,134.36 went to a fair fund); In the Matter of Summit Financial Group, Inc., Adm. Proc. File No. 3-20149 (Nov. 13, 2020)(based on same product; resolved with a cease and desist order based on the same Advisers Act Section and Rule and a censure; Respondent will also pay disgorgement of $3,083.59, prejudgment interest of $715.49 and a penalty of $602,799.08; a sum for client losses was paid into a Fair Fund); In the Matter of Securities America Advisors, Inc., Adm. Proc. File No. 3-20150 (Nov. 13, 2020)(based on two similar products; resolved with consent to entry of a cease and desist order based on same Adviser Section and Rule and a censure; payment of disgorgement of $3,399.42, prejudgment interest of $377.40 and a penalty of $600,000; fair fund created); and In the Matter of Royal Alliance Associates, Inc., Adm. Proc. File No. 3-20152 (Nov. 13, 2020)(based on VXX; settled with consent based on same Section and Rule; payment of $1,953.00 in disgorgement, $447.29 in prejudgment interest; and a penalty of $500,000; a fair fund was established). See also In the Matter of Morgan Wilshire Securities, Inc., Adm. Proc. File No. 3-29954 (Sept. 24, 2020)(Action centered on purchasing inverse EFTs without regard to the holding period where firm staff not properly trained).