A key focus of SEC enforcement has been the retail investor. To that end the Division formed a special unit to focus on cases tied to those investors. Numerous cases have been brought. That focus may also be at least in part responsible for the continued increase in enforcement cases brought against investment advisers.

At the same time, it is not difficult to lose track of what the retail investor focus actually means – particularly through a seeming maze of regulations and enforcement actions.

Recent remarks by Joshua Sterling, Director of the Division of Swap Dealers and Intermediary Oversight at the CFTC, speaking at an Investment Management Conference in Chicago earlier in November 2019 (here) provides a reminder.

The remarks

Mr. Sterling discussed the markets, asset managers, regulators and the retail investor. He began with the bar and its relation to the markets. Those markets, a function of an open society based on respect for natural rights and law, have afforded a “broad and grand wealth unparallel in human history . . .” he noted. The bar is a “protector of freedom . . .” and the system which created those markets, echoing ideas introduced to the securities markets as the “access theory” by Irv Pollack and Stanley Sporkin in the early 1970s. Under that theory it is the bar and other market professionals which help safeguard the markets by acting as gatekeepers.

Today the asset management business is bigger, faster and stronger than ever, according to the Director. Bigger means that over the past “several years, investors have generally pushed their assets into a smaller set of very large funds.” Bigger also translates into more efficiency and better pricing to the point where some funds are offering “no fee” share classes.

Faster in the asset management business is often a function of technology with new ways to invest. Some firms, for example, rely entirely on algorithms and other quantitative tools. Others are a blend of traditional methods and new techniques. And, larger is the product of strategic transactions and business flows tied to investor preference.

The result is that asset managers are among the largest participants in the markets today. They have become the providers of market liquidity which “is also to transmit risk,” according to the Director. As the these trends continue, asset managers will grow to have an even larger impact on the markets.

Bigger, faster, stronger couples not only with the transmission of risk, but also means that regulators must evolve the way they oversee investment management. The role of regulators such as the CFTC should be “not to call the shots in the evolution of the asset management industry, but to promote the strength, and vibrancy of the markets in which asset managers operate.”

Better, faster, stronger also only ties to the retail investor, illustrated by Mr. Sterling with a very personal story: “As a kid, I remember the day my father came home with a new and rather basic Ford Ranger pickup; the only extra was the red paint. Times were tight. But my parents always invested, and they had the opportunity to make prudent choices based on the myriad of sound investment products available to retail investors. My parents are now enjoying their golden years with a solid nest egg built over decades of hard work and savings.”

Comment

The markets afford all significant opportunities as the Director notes. In years past those opportunities permitted sound investment decisions by many who were retail investors. While that may still be true today, much has changed.

Today “better, faster, stronger” means it is likely those same retail investor investment decisions are being made by investment managers, whether they are in the securities or commodity markets. The goal, however, is still the same – to create the opportunity that Mr. Sterling’s parents had and which they are now enjoying. This comes from a balance of market professionals adhering to the access theory, regulators facilitating fair and liquid markets, and investment professionals honoring their duties to their retail investor clients.

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In the future the Commission appears to be facing heavy headwinds. One critical question is always the budget. The budget published earlier this year was at $705 million. Whether that amount will be approved is unclear.

There are also questions about the statute of limitations following Kokesh. While legislation is pending that would extend the limitation period it is unclear if it will pass. And, there are questions about the availability of disgorgement as a remedy in the future in view of the Lui case. One might argue that uncertainty on such key issues should spell a difficult fiscal 2020. Perhaps not. The agency has often been at its best and most creative under such circumstances.

Looking back last week the trial victory in the Lek case is a positive. The case presented a complex fact pattern centered on manipulative schemes with a number of variations, all of which had to be presented to a jury. That jury seemed to have no difficulty in finding for the Commission. That type of result bodes well for the Commission and its mission to monitor the markets.

A look forward – a look back:

SEC

Whistleblowers: The Commission awarded over $260,000 to three whistleblowers who were instrumental in alerting the agency to a “well-concealed” fraud (Nov. 15, 2019).

SEC Enforcement – Litigated Actions

Manipulation: SEC v. Lek Securities Corporation, Civil Action No. 17-cv-1789 (S.D.N.Y. Verdict Nov. 12, 2019). The SEC prevailed in a cross-border market manipulation scheme keyed to a layering technique that generated more than $25 million in illicit profits. The firm, Avalon FA Ltd., is based in Kiev, Ukraine and was controlled by defendants Nathan Fayyer and Sergey Pustelnik.

The action centered on trading by Avalon FA Ltd. through Lek Securities Corporation. The firm was a day-trader that uses mostly foreign traders. During the period of this action the trading firm had an account at Lek Securities, a New York City registered broker-dealer.

Avalon began implementing a manipulative scheme through its account at Lek in 2010. The scheme used spoofing or layering to generate profits over a period of about six years. Spoofing or layering involves the use of non-bona fide orders for a particular security placed to move the price in a specific direction. Those orders inject false information into the market place because they appear to be actual transactions when in fact they are not. The non-bona fide orders essentially create a false trend in the market in one direction, either moving the share price up from purchases or down from sales, to the detriment of other traders. As the market moved Avalon would take advantage of the price changes to place profitable orders in the opposite direction. The non-bona fide orders were then cancelled. This yielded trading profits for Avalon at the expense of other traders who entered into transactions at what were essentially artificial prices.

The jury returned a verdict finding that the Defendants violated Securities Act Section 17(a)(1) and (3) and Exchange Act Section 10(b). In addition, Messrs. Fayyer and Pustelnik were found to be control persons within the meaning of Exchange Act Section 20(a). The Court will consider the question of remedies following briefing.

SEC Enforcement – Filed and Settled Actions

The Commission filed 1 civil injunctive action and no administrative proceeding last week, exclusive of 12j and tag-along actions.

Crypto fraudulent offering: SEC v. Middleton, Civil Action No. 19-cv-4625 (E.D.N.Y.) is a previously filed action which named as defendants: Veritaseum Inc., Veritaseum LLC, and their owner, Reginald Middleton. The complaint alleged a fraudulent offering involving a virtual currency called VERI. Defendants made a series of false representations in marketing the coins in an unregistered offering to retail investors. The Court entered final judgments by consent as to each Defendant. Each was permanently enjoined from future violations of Securities Act Sections 5(a), 5(c) and 17(a) and Exchange Act Section 10(b). The injunctions contained a prohibition from participating in crypto offerings in the future. All Defendants were ordered to pay disgorgement, on a joint and several basis, of $7,981, 600, prejudgment interest of $582,535 and a penalty of $1 million. The judgment also established a fair fund and appointed a distribution agent. See Lit. Rel. No. 24665 (Nov. 14, 2019).

Offering fraud: SEC v. KRM Services, LLC, Civil Action No. 1:19-cv-1424 (E.D. Va. Filed Nov. 8, 2019) is an action which names as defendant Roberto Clark and his firm, KRM Services. Over a three year period, beginning in late 2016 and continuing until early 2019, he solicited individuals to make short term loans to KRM and invest in its unregistered shares. The funds were to develop a motorized surf board. About 350,000 was raised from a number of investors. Portions of the funds were misappropriated. The complaint alleges violations of Securities Act Sections 5(a), 5(c) and each subsection of 17(a). The case is pending. See Lit. Rel. No. 24662 (Nov. 8, 2019).

CFTC

Spoofing: In the Matter of Tower Research Capital LLC, CFTC Docket No. 20-06 (Nov. 6, 2019). Tower Research was previously registered with the agency as a commodity trade adviser and pool operator. Those registrations were withdrawn. Now the New York based firm is a proprietary trader on the Chicago Mercantile Exchange or CME. Over a two-year period, beginning, in the first quarter of 2012, the firm used three traders to place numerous futures market transactions, often in mini S&P, E-mini NASDAQ 100 and E-mini Dow ($5) Futures contracts. The traders typically placed one or more orders they wanted filled on one side of the market. Frequently, the position only showed a small quantity available. On the opposite side of the market one or more orders were placed that the trader intended to cancel. This order was typically fully visible. The point was to induce other market participants to quickly respond to the partially visible orders the trader wanted filled, thereby obtaining better execution by creating a false impression of supply and demand. These orders would be canceled as the fills came in for the others. The three traders at Tower Research repeated this technique multiple times over the two year period. Millions of trades were placed and filled while others were placed in the market and then cancelled, repeatedly deceiving other market participants. The trading approach used by Tower violated Section 4c(a)(5)(C) of the CEA which prohibits the trading practice known as spoofing. It also violated Section 6(c)(1) of the Act and regulation 180(1) thereunder which precludes manipulative and deceptive conduct. To resolve the proceedings Tower consented to the entry of a cease and desist order based on the sections cited in the Order. The firm also agreed to pay restitution of $32,593,894, a penalty of $24, 400,000 (reduced through cooperation) and disgorgement of $10,500,000. Offsets are included for payments made to the DOJ. Tower also settled with the DOJ, entering into a deferred prosecution agreement.

FCPA/Anti-Corruption

U.S. v. Li (S.D.N.Y. Filed Nov. 14, 2019) is an action which names as defendants Yanliang Li and Nongwei Yank, both citizens of China and former employees at the subsidiary in that country of an international multi-level marketing firm based in Los Angeles. The indictment alleges a decade long corruption scheme keyed to bribing Chinese officials and then covering up the wrongful conduct. The bribes were booked as business expenses over the ten year period. To avoid authorities, false testimony was given and computers were wiped clear to avoid having to produce information. Mr. Li was charged with one count of conspiracy to violate the FCPA, one count of perjury and one count of destruction of records in a federal investigation. Ms. Yang was charged with one count of conspiracy to violate the FCPA. The case is pending. See also SEC v. Li, Civil Action No. 19-cv-10562 (S.D.N.Y. Filed Nov. 14, 2019).

Australia

Remarks: Karen Chester, Deputy Chair, Australian Securities and Investment Commission, delivered the opening remarks at the Regulators 2019 Conference, Sydney (Nov. 15, 2019). Her remarks focused on fairness and transparency in the regulatory process and provided insights on disclosure (here).

Singapore

Remarks: Ravi Menon, Managing Director, Monetary Authority of Singapore, delivered the opening remarks at the BIS -World Bank Roundtable on Impact of Technology on Financial Inclusion and Financial Stability (Nov. 13, 2019). His remarks focused on the importance of innovation and digital finance in achieving sustained and meaningful financial inclusion (here).

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