Cryptocurrencies continued to be an important topic of discussion this week. The Chairman of the SEC and the Chairman of the CFTC testified before the Senate Banking Committee on the subject.
Securities class actions filings continued to surge this week. NERA and Cornerstone published reports stating that the number of securities class actions filed in 2017 increased significantly over the prior year. This is consistent with the overall trend in recent years.
Finally, OCIE published their exam priorities for the year.
Testimony: Chairman Jay Clayton testified before the House Committee on Financial Services on the SEC’s Agenda, Operations, and Budget. In his testimony the Chairman reviewed: the cyber security difficulties of the agency; the facilitation of capital formation and disclosure effectiveness; standards of conduct for investment advisers and broker-dealers; the securities swaps market; enforcement; and the necessary resources for moving forward.
Inspections: The staff Office of Compliance Inspections and Examinations Announced the 2018 Examination Priorities (here).
SEC Chairman Jay Clayton and CFTC Chairman J. Christopher Giancario testified before the Senate Banking Committee on Cryptocurrencies. Each essentially reiterated earlier comments they have made regarding the markets, their regulatory approach to those markets and the enforcement actions brought by their respective agencies. Each Chairman also expressed optimism regarding the opportunities the new technology may hold for the future. See SEC Chairman Jay Clayton, Testimony on Virtual Currencies: The Oversight Role of the U.S. SEC and the U.S. CFTC, Senate Committee on Banking (Feb. 6, 2018)(here); CFTC Chairman J. Christopher Giancario, Testimony Before the Senate Banking Committee (Feb. 6, 2018)(here).
Securities Class Actions
Two new reports chronicle the significant upward trend not just in the number of securities class actions filed in 2017 but also the increased chance for U.S. and foreign issuers to be named in such a suit. See Cornerstone Research, Securities Class Action Filings: 2017 Year in Review (here); NERA, Recent Trends In Securities Class Action Litigation: 2017 Year in Review (here). Together the reports provide a detailed analysis of trends in securities class actions.
Cornerstone and NERA agree that last year significantly more securities class actions were filed than in the prior year, although they disagree on the precise number because of the manner in which each compiles statistics. NERA, for example found that in 2017 432 securities class actions were filed. That compares to just 300 securities class action suits file in 2016, 229 suits in 2015 and 218 suits in 2014. The increase in filings last year is consistent with a trend over the last few years. There are, however, indications that the upward trend may not continue.
SEC Enforcement – Filed and Settled Actions
Statistics: Last week the SEC filed 1 civil injunctive case and 2 administrative proceedings, excluding 12j and tag-along proceedings.
Due Diligence-required muni disclosures: In the Matter of John T. Lynch, Jr., Adm. Proc. File No. 3-17902 (Feb. 6, 2018). Respondent Lynch served as the managing director of Lawson Financial Corporation. He is an inactive member of the Pennsylvania bar. Over a three year period, beginning in June 2010, he served as an investment banker and underwriter’s counsel for Lawson. During the period there was a series of municipal offerings in the Southeast involving millions of dollars that were known as the Brogdon Bond Offerings. A key representation in those offerings was that the issuer had made all the required financial disclosures and would update those representations as required. In fact the issuer failed to do so. Mr. Lynch, while serving in his positions, only gave the offerings a cursory review, failing to conduct proper due diligence. Nevertheless, he was paid for both of his roles despite failing to carry out his duties. The Order alleges violations of Securities Act Sections 17(a)(2) and (3). To resolve the proceedings Mr. Lynch consented to the entry of an order barring him from association with any broker or dealer and from serving in any capacity with an advisory board, investment adviser or depositor of or principal underwriter of a registered investment company or an affiliate.
Customer Protection Rule: In the Matter of Wedbush Securities, Inc., Adm. Proc. File No. 3-18357 (Feb. 5, 2018). The firm is a dual registered broker dealer and investment adviser based in Los Angeles. The proceedings center on Exchange Act Rule 15c-3, the customer protection rule. That rule requires broker dealers that maintain custody of customer securities and cash to safeguard those assets by segregating them from the broker dealer’s proprietary business activity. Then in the event the firm fails, the segregated securities and cash will be available to cover those of the customers. The amount of the reserve is calculated using a formula appended to the rule. Essentially that formula requires the broker dealer to net its obligations to the customers against those of the customer to the firm. Typically, broker dealers calculate the amount of the reserve weekly. Wedbush made the customer reserve calculation on a weekly basis. In funding its reserve the firm typically maintained a cushion over and above the required amount as a hedge against calculation and other errors, thereby ensuring compliance. In 2014 and 2015 however, the firm had a coding error in the programing used to make the calculation which left Wedbush under-funded. Thus from September 2014 through January 2015 the reserve was under funded by amounts that ranged from $10 million to $193 million on a weekly basis. This resulted in the firm not being in compliance with the rule and filing incorrect FOCUS reports which contained the numbers related to the reserve. To correct the deficiency the firm was required to deposit $133 million in easily accessible funds. Wedbush could not immediately fund the obligation. To the contrary it took the firm several weeks to fund it. This is not the first regulatory violation by Wedbush. Previously the firm has been sanctioned for violations by the Commission, FINRA and Nasdaq five times. It also settled charges with FINRA concurrent with the filing of these proceedings. The Order alleges violations of Exchange Act sections 15(c)(3) and 17(a)(1). In resolving the proceedings the firm agreed to retain an independent consultant to review its procedures and make appropriate recommendations. In addition, Wedbush consented to the entry of a cease and desist order based on the sections cited in the order and agreed to pay disgorgement in the amount of $275,851 along with prejudgment interest of $28,346 and a penalty of $1 million.
Misrepresentation re stock sale: SEC v. Hadsell Chemical Processing, LLC, Civil Action No. 2:17-cv-432 (S.D. Ohio) is a previously filed action against the firm and its former President, Robert Walton, Jr. The complaint alleged that Mr. Walton made material misrepresentations to a group of investors in connection with the sale of about $12 million of promissory notes. Specifically, he claimed that the notes were guaranteed, that the firm had received multi-million dollar contracts and that it was profitable. None of those claims were true. The Court entered a Final Judgment against Mr. Walton directing that he pay disgorgement of $506,471.86, prejudgment interest of $51,183.66 and a civil penalty of $506,471.86. See Lit. Rel. No. 24041 (Feb. 2, 2018).
Offering fraud: SEC v. Genovese, Civil Action No. 18 cv 942 (S.D.N.Y. Filed Feb. 2, 2018) is an action which names as defendants Nicholas Genovese and his firms, Willow Creek Investments, L.P. and Willow Creek Advisers, L.L.C. The action alleges that since 2014 the Defendants have raised over $5.3 million from about six investors based on a series of misrepresentations. The misrepresentations centered on the background and expertise of Mr. Genovese and the operations of his hedge fund and its investment adviser. In addition, Mr. Genovese and his firms misappropriated investor funds and used much of the money in securities trading, sustaining losses exceeding $8 million over a two year period. Other portions of the investor money were used for personal expenses. The complaint alleges violations of Securities Act Section 17(a), Exchange Act Section 10(b) and Advisers Act Sections 206(1), 206(2) and 206(4). The Commission obtained a freeze order on filing. The Manhattan U.S. Attorney’s Office filed a parallel criminal action. See, Lit. Rel. No. 204038 (Feb. 2, 2018).
Offering fraud: SEC v. Boston Trading and Research, LLC, Civil Action No. 1:10-cv-11841 (D. Mass.) is a previously filed action which names as defendants the now defunct firm’s principals, Ahmet Devrim Akyil and Craig Kartis. The action alleges that the Defendants raised millions of dollars from investors with fraudulent claims regarding their forex trading fund. Specifically, investors were falsely told that they were guaranteed against trading losses. Defendants diverted portions of the investor funds to their personal use. A substantial portion of the remaining funds were lost trading in the forex markets. Investors were also sent false account statements. Mr. Karlis settled with the Commission and the Court entered a final judgment, enjoining him from future violations of Exchange Act Sections 10(b) and 15(a)(1) and Securities Act Sections 5(a), 5(c) and 17(a). In addition, he was directed to pay disgorgement in the amount of $1,641,067.76 and prejudgment interest of $549,376.92 which is deemed paid by the restitution order entered in the related criminal proceedings. He is also permanently barred from associating with any broker or dealer. The case against Mr. Akyil is continuing. See Lit. Rel. No. 24039 (Feb. 2, 2018).
Internal controls: The Securities and Futures Commission reprimanded Credit Suisse (Hong Kong) Limited and its affiliates and fined them $39.3 million. The control failures were: not segregating client securities; not ensuring compliance with short selling requirements; not ensuring that a pre-trade control for its electronic algorithm trading systems was properly configured; not ensuring suitability on certain risk mismatched transactions for clients; and not disclosing certain information to clients. In resolving the matter the SFC took into consideration the fact that Credit Suisse self-reported, engaged independent reviewers, took remedial steps, agreed to strengthen internal controls and to compensation clients.