by T. GormanPosted on Posted in SECActions

The Commission passed Regulation Best Interest this week (here). The new Regulation governs the obligations of broker-dealers giving advice to retail investors, raising the existing standard. While it was built on the kind of fiduciary duty principles that govern investment advisers, the Commission declined to impose that standard on brokers.

The Commission also brought three enforcement actions this week. One centered on a crypto offering which the agency claims should have been registered under the Securities Act; another involved the under valuation of assets by an investment adviser that failed to follow its own procedures; and a third case centered on a Ponzi scheme run from a fraternity house.

SEC

The Commission adopted Regulation Best Interest by a 3-1 vote this week (here). The Regulation governs recommendations made by broker-dealers to retail investors. It is built on four principles: First: The Disclosure Obligation regarding services, fees, limitations and conflicts. Second: The Care Obligation which requires the broker to exercise reasonable diligence before making the recommendation. Third: The Conflict of Interest Obligation which requires the adoption of specific policies and procedures keyed to the question of conflicts. Fourth: The Compliance Obligation which requires the adoption of specific policies and procedures to enforce the Regulation as a whole.

SEC Enforcement – Filed and Settled Actions

The Commission filed 3 civil injunctive actions and 1 administrative proceeding this week, exclusive of 12j and tag-along actions.

Financial fraud: SEC v. Longfin Corp., Civil Action No. 1:19-cv-05296 (S.D.N.Y. Filed June 5, 2019) is an action which names as defendants the company, a firm whose shares were delisted by NASDAQ but was traded in the over-the-counter market, and Venkata Meenavalli, its founder, Chairman and CEO. The complaint centers on a fraudulent scheme to sell shares under Reg. A and secure a listing on NASDAQ. To secure the listing the company misrepresented its status – it falsely claimed to be based in the U.S. In fact, Mr. Meenavalli placed substantially all of the assets outside the United States. After receiving a qualification regarding the offering from the SEC in June 2017, Defendant realized enough shares would not be sold in the offering at $5 per share to qualify for a listing. Accordingly, the firm distributed shares to insiders and affiliates, creating the false impression that the requisite number of shares had been sold. Later the firm announced the acquisition of a cryptocurrency business which caused the share price to skyrocket to over $140 per share. During 2017 and 2018 Defendants also falsified the revenue of the company by engaging in a series of fraudulent, roundtrip transactions involving the firm and Meenavalli-controlled entities. The complaint alleges violations of Securities Act Section 17(a) and Exchange Act Sections 10(b), 13(a), 13(b)(2)(A) and (b) and 13(b)(5). The complaint is pending. See also SEC v. Altahawi, Civil Action No. 1:18-cv-02977 (S.D.N.Y.)(action against Andy Altahawi, president of Adamson Brothers Corp. which operates impoflow.co, a website that claims to be a leading equity Reg A+ platform and who was involved with the listing for Longfin; the complaint was amended to reflect this new action). A parallel criminal action was filed by the U.S. Attorney for the District of New Jersey.

Crypto currency: SEC v. Kik Interactive, Inc., Civil Action No. 19-cv-5244 (S.D.N.Y. Filed June 4, 2019). Kik is a privately-held Canadian corporation based in Waterloo, Ontario. Founded in 2009 the firm’s only line of business was the Kik Messenger, a mobile software application that permitted users to communicate with each other on mobile devices. By 2016 the popularity of the Kik Messenger app waned. The firm decided to create a crypto story as a new way to raise capital and survive. The Kik CEO summarized the strategy this way: The firm would “’sell some [tokens] to crypto investors to raise money,’ and that ‘[m]ore demand’ for the token would mean ‘[v]alue goes up’ and, therefore: ‘Buy today, sell tomorrow, profit.’” By May 2017 Kik’s CEO told the board that he expected to announce a token offering for a coin they called the Kin that month. The proceeds from the offering would be used to build the “’Kin Ecosystem’ and fund company operations.” Three million tokens would be offered in multiple tranches. The Ecosystem was essentially a continuous PR campaign for the Kin funded with the sale proceeds obtained from investors who were in fact told the plan. The basic idea echoed the CEO’s vision – more PR equals more interest, more sales and higher profits for investors who purchased coins and the company which retained a large number of coins. Overall about 10,000 investors paid approximately $100 million for the digital assets. The offering was never registered with the Commission. The complaint alleges violations of Securities Act Sections 5(a) and 5(c). The complaint is pending.

Asset valuation: In the Matter of Deer Park Road Management Company, L.P., Adm. Proc. File No. 3-19190 (June 4, 2019) is a proceeding which names as Respondents, the registered investment adviser and Scott Burg, the firm’s CIO. Over a three year period, beginning in October 2012, the firm failed to properly implement compliance procedures regarding the valuation of certain assets. While the firm’s procedures called for the maximization of observable inputs regarding valuation when valuing residential mortgage-backed securities or RMBS, the assets were undervalued because of a failure to comply with that obligation. Mr. Burg caused that failure. The Order alleges violations of Advisers Act Section 206(4). To resolve the proceeds each Respondent consented to the entry of a cease and desist order based on the section cited in the Order. The firm also consented to the entry of a censure. The Advisor and Mr. Berg will pay penalties of, respectively, $5 million and $250,000.

Pyramid scheme: SEC v. TelexFree, Inc., Civil Action No. 14cv-11858 (D. Mass.) is a previously filed action against the company, Faith Sloan and others. The complaint alleged a pyramid scheme targeting the Latino community. The Court entered a final judgment prohibiting future violations of Section 5 of the Securities Act by Ms. Sloan. In addition, the order directs the payment of $1,271,215 in disgorgement and prejudgment interest and a $7,500 penalty. The monetary portion of the judgment is deemed partially offset by an order requiring Defendant Sloan to transfer certain assets to settle an adversary action in a related case. Previously, the parties agreed to dismiss the fraud claims. The company and others entered into settlements earlier. See Lit. Rel. No. 24488 (June 4, 2019).

Offering fraud: SEC v. Arbab, Civil Action No. 3:190cv00055 (M.D. Ga. Filed May 31, 2019) is an action which names as defendants Syed Arham Arbab, a 22 year old resident of a fraternity house, and his two firms, Proficio Capital Investments, LLC and Artis Proficio Capital Management, LLC. Beginning in May 2018, and continuing to the present time, Defendant Arab sold interests through the two entity Defendants in a purposed hedge fund. The interests were supposedly bond agreements, a kind of promissory note. The investments paid very high returns, according to the representations made to investors. Over the last year Defendants have raised at least $269,000 from eight or perhaps more investors. In fact there was no fund. Defendants simply misappropriated the investor funds. The complaint alleges violations of each subsection of Securities Act Section 17(a), Exchange Act Section 10(b) and Advisers Act Sections 206(1), 206(2) and 206(4). The Court granted the Commission’s quest for a temporary freeze order. The case is pending.

Hong Kong

Offering proceeds: The Securities and Futures Commission commended legal proceedings following an investigation against Au Yeung Ho Yin. The investigation demonstrated that a substantial portion of the global offering proceedings of Fujian Nuoqi Co. Ltd., a firm listed on the Hong Kong exchange, were made shortly after the company listed on SEHK in January 2014. Au Yeung had knowledge of red flags regarding the withdrawals. He failed, however, to discharge his duties as CFO, and later as an executive director of the firm, by not properly inquiring into the basis for transactions, failed to alert the board of directors, and did not ensure disclosure.

FCPA Institute: On June 21 and 22, 2019, Professor Mike Koehler will conduct the FCPA Institute at the Offices of Dorsey & Whitney LLP in Minneapolis, Minnesota. The Institute provides a unique learning experience for those seeking to elevate their knowledge of the Foreign Corrupt Practices Act. Professor Koehler is one of the foremost scholars on the FCPA and conducts an interesting and most informative program. The program is live in Minneapolis and also webcast. You can obtain more information about the program and register here.

Tagged with: , , ,

by T. GormanPosted on Posted in SECActions

The Commission resolved a long simmering issue by a 3-1 vote, adopting Regulation Best Interest which details the standard applicable when a broker-dealer or registered representative makes a recommendation to a retail customer. While the regulation was proposed in April 2018 and modified in adoption, the debate about the governing standard has continued for a much longer period. The question of whether to adopt the fiduciary duty standard of an investment adviser, the requirements of ERISA or perhaps a new and different standard has been difficult.

While the adopting release is lengthy and complex (here), the Regulation is built on four basic principles.

First: The Disclosure Obligation. Prior to, or when making a recommendation, the broker-dealer or registered representative “must disclose, in writing, all material facts about the scope and terms of the relationship with the customer.” This includes disclosure of the capacity in which the broker is acting, material fees and costs that will be incurred, the services to be provided and any limitations. The broker must also disclose all material conflicts.

Second: The Care Obligation. This obligation requires that the broker “exercise reasonable diligence and care and skill when making a recommendation to a retail customer.” Before making a recommendation the broker-dealer must consider and evaluate the recommendation and alternatives. The Release makes it clear that compliance with this obligation must be assessed as of the time the recommendation is made, not with hindsight.

Third: The Conflict of Interest Obligation: While disclosure of material conflicts is required by Obligation One, the subject is revisited here. Under this obligation the broker-dealer is required to establish, enforce and maintain reasonably designed written policies and procedures that address conflicts of interest associated with recommendations to retail customers. These policies and procedures must be designed to identify all conflicts and mitigate those that create an incentive for the broker to put the interests of the firm ahead of the those of the retail customer. They must also identify and eliminate “sales contests, sales quotas, bonuses, and non-cash compensation that are based on the sale of specific securities or specific types of securities within a limited period of time.”

Fourth: The Compliance Obligation: The broker-dealer is also required to establish, implement and enforce a second set of policies and procedures. These must be designed to achieve compliance with the Regulation as a whole.

The obligations imposed by the Regulation are limited to those situations when a broker-dealer is making a recommendation. They were crafted “to draw on key principles underlying fiduciary obligations, including those that apply to investment advisers under the Advisers Act, while providing specific requirements to address certain aspects of the relationships between broker-dealers and their retail customers. The Regulation enhances the obligations of the broker-dealer when making a recommendation, but do not simply adopt those of an investment adviser.

To the contrary, the obligations of the Regulation are specifically focused on the relation between a broker-dealer and a retail customer, according to the Release. They are designed “to help customers better understand and compare the services offered by broker-dealers and investment advisers and make an informed choice of the relationship best suited to their needs and circumstances . . .”

In the end, the point is to aid the retail investors decision making process when evaluating investment options. Thus “regardless of whether a retail investor chooses a broker-dealer or an investment advisor (or both), the retail investor will be entitled to a recommendation (from a broker-dealer) or advice (from an investment adviser) that is in the best interest of the retail investor and that does not place the interests of the firm or the financial professional ahead of the interests of the retail investor,” according to the Release. Key to all of this, of course is the implementation of the Regulation.

FCPA Institute: On June 21 and 22, 2019, Professor Mike Koehler will conduct the FCPA Institute at the Offices of Dorsey & Whitney LLP in Minneapolis, Minnesota. The Institute provides a unique learning experience for those seeking to elevate their knowledge of the Foreign Corrupt Practices Act. Professor Koehler is one of the foremost scholars on the FCPA and conducts an interesting and most informative program. The program is live in Minneapolis and also webcast. You can obtain more information about the program and register here.

Tagged with: , , ,