This Week In Securities Litigation (Week of December 21, 2020)

The exit from the Commission continued this week with the resignation of the Director of Trading and Markets. By year end much of the senior staff, along with the Commission Chairman, will depart from the agency.

The Commission filed a series of enforcement actions last week. A number of those cases centered on financial related issues and false statements such as the actions against broker-dealer Robinhood and China based Luckin coffee. Others centered on issues such as financial impairment and the disclosure of known trends in periodic reports.

Be safe and healthy this week


Reports: The Commission released two reports regarding Nationally Recognized Statistical Rating Organizations on December 18, 2020. One is the annual report on these organizations which reviews a number of topics including the state of competition, transparency and conflicts (here). The second summarizes the staff examinations and findings from their reviews (here).

Whistleblowers: The Commission announced three new whistleblower awards totaling $3.6 million on December 18, 2020. A separate award of $400,000 was announced on December 14, 2020.

Report: The Office of the Advocate for Small Business Capital Formation issued its annual report on December 18, 2020 (here). The report provides a set of data tables and a summary of the work of the Office.

Swaps: The Commission announced the formation of the Security-Based Swaps Joint Venture on December 18, 2020 (here). The Joint Venture will be led by the Division of Examinations and the Division of Trading and Markets. It will be responsible for coordinating functions related to the regulation of security-based swaps and oversight of certain entities that will be required to register with the agency.

Rules: The agency announced the adoption of the final rules regarding the disclosure of payments by resources extraction issuers on December 16, 2020 (here). The rules, which implement Exchange Act Section 13q, require issuers to provide information about the total amount of payments made to each government. The data must be furnished in an interactive format.

Rules: The Commission adopted a rule that will exempt from the definition of “clearing agency” in Section 3(a)(23) of the Exchange Act certain activities of a registered security-based swap dealer, a registered security-based swap execution facility, and a person engaging in dealing in activity in security-based swaps that are eligible for an exemption from registration as such a swap because the quantity of dealing activity is de minimis (here). The provision was adopted on December 16, 2020.

Alert: OCIE published its “Observations from Examinations of Broker-Dealers and Investment Advisers: Large Trader Obligations, on December 16, 2020 (here). The Alert details the observations of the Office regarding compliance under Rule 13h-1.

SEC Enforcement – Filed and Settled Actions

The Commission filed 8 civil injunctive actions and 4 administrative proceedings last week, excluding 12j, tag-along proceedings and other similar matters.

Best execution – false statements: In the Matter of Robinhood Financial, LLC, Adm. Proc. File No. 3-20171 (Dec. 17, 2020) is a proceeding which names the Commission and FINRA registered broker-dealer as a respondent. The proceedings center on the manner in which the firm secures the execution of customer orders, its compliance procedures and the statements made about those topics. Specifically, Robinhood’s business mode requires that customers not be charged for the execution of orders. The firm secures payment by charging for order flow. From the beginning of its operations in 2015 through 2019 the firm demanded and was paid for order flow at prices that generally exceeded those of the market. As a result, the execution of Robinhood customer orders was slow – customers did not receive best execution. While the firm began to study the question in 2018 when the issue was raised in the market place, Robinhood continued to insist that customs received good execution. By 2019 the firm’s internal analysis demonstrated this was incorrect. Until then Robinhood did not have policies and procedures in place that would have ensured proper execution. The Order alleges violations of Securities Act Section 17(a) and Exchange Act Section 17(a) and Rule 17a-4. To resolve the case the firm agreed to implement a series of undertakings. It also consented to the entry of a cease-and- desist order based on the Sections and Rule cited in the Order and to a censure. In addition, Robinhood agreed to pay a penalty of $65 million. A Fair Fund will be created.

Impairment: In the Matter of Jason Boling, CPA, Adm. Proc. File No. 3-20176 (Dec. 17, 2020) is an action which names as a respondent Mr. Boling, the CFO of Apex Global Brands, Inc. during the period here. Throughout 2017 Apex failed to properly record impairment charges tied to its primary assent and only revenue source – certain trademarks. During the period Apex was experiencing a series of significant setbacks in its business. Although the trademarks were impaired and there should have been charges of $34.5 million, they were not recorded. Mr. Boling was aware of the information regarding impairment but failed to require the write downs. The Order alleges violations of Exchange Act Section 13(b)(2)(A), charging that Respondent caused the violation. To resolve the proceedings, Respondent consented to the entry of a cease-and-desist order based on the Section cited in the Order. He also will pay a penalty of $10,000 which will be transferred to the Treasury. See also In the Matter of Apex Global Brands Inc., FKA Cherokee Inc., Adm. Proc. File No. 3-20175 (Dec. 17, 2020)(based on conduct outlined above; resolved with cease and desist order based on Securities Act Section 17(a)(2) and (3) and Exchange Act Sections 13(a), 13(b)(2)(A) and 13(b)(2)(B) and the applicable rules).

Disclosure of trends: In the Matter of Dentsply Sirona Inc., Adm. Proc. File No. 3-20170 (Dec. 16, 2020) names the firm as a respondent, a seller of dental technologies equipment. DSI sold more of its product to an exclusive distributor for the U.S than the customer could sell. By the second quarter, DSI knew that the distributor wanted to renegotiate its deal. Indeed, in each quarter of the year DSI was aware of the trends or uncertainties and that they were reasonably likely to have a material and unfavorable impact on sales or revenues. Nevertheless, when preparing its filings the trends were not disclose. The Order alleges violations of Exchange Act Section 13(a) and Rules 12b-20 and 13a-13. To resolve the proceedings Respondent consented to the entry of a cease-and-desist order based on the Section and Rules cited in the Order. DSI also agreed to pay a penalty of $1 million which was transferred to the Treasury.

Financial fraud: SEC v. Luckin Coffee, Inc., Civil Action No. 1:20-cv-10631 (S.D.N.Y. Filed December 16, 2020). Luckin is a retail coffee provider, formed in the Cayman Islands and based in Fuijian, China. The firm’s business model is premised on the assumption that there is a large, unmet demand for coffee in China. In May 2019 Luckin engaged in an IPO of ADS in the U.S., raising about $600 million. The materials reported that the company was formed in October 2017. By March 31, 2019 it was operating 2,370 stores in 28 cities across China. The company reported 16.8 million transacting customers. It had become China’s second largest coffee store; it was the fastest growing coffee network. Luckin’s goal was to be the largest coffee network. The prospectus acknowledged early losses. The same document reported that at year end 2018 Luckin had total revenue of USD $125 million. At the end of the first quarter of 2019 Luckin reported revenue of USD $71.3 million keyed to what was described as “strong growth.” Luckin repeated its ambition to be the largest coffee network in China. In the months before the IPO kicked off, news reports highlighted the firm’s “meteoric expansion” and its “stunning” and “super-charged” growth pattern at “break-neck speed.” Luckin’s initial pre-IPO valuation of USD $1 million in July 2018 was recalibrated to USD $2.2 billion by November 2018 to USD $2.9 billion in April 2019. In May 2019 the IPO price of USD $17 per share valued the company at USD $3.9 billion. The over a handful of months were the product of three fraudulent schemes tied to coupons that were controlled by insiders. Revenue for coupons was recognized when it was used by the customer. These schemes generated over USD $300 million in total fabricated revenue. All of this revenue was carefully tracked on a parallel set of firm books. The finance department of Luckin only had access to the fake revenue books, not the real corporate books. The fraud emerged during an annual external audit for the Luckin’s financial statements. Luckin then announced it. The share price dropped from USD $27.19 on March 31, 2020 to USD $3.39 per ADS on April 6, 2020. The complaint alleges violations of Securities Act Section 17(a) and Exchange Act Sections 10(b), 13(a), 13(b)(2)(A) and 13(b)(2)(B). Luckin took remedial acts and cooperated with the Commission. It resolved the case by consenting to the entry of permanent injunctions based on the Sections cited in the complaint. In addition, the company will pay a penalty of $180 million which may be offset by payments made to shareholder in the provisional liquidation in the Cayman Islands.

Pyramid Scheme: SEC v. Chairez, Civil Action No. 1:20-cv-10582 (S.D.N.Y. Filed Dec. 15, 2020) is an action which charges Karin Chairez with being a promoter of the AirBit Club investment scheme that targeted the Latin and Spanish-speaking communities. She is charged with acting as an unregistered broker. The Commission previously filed a complaint centered on this fraudulent scheme which is pending (here). See also Lit. Rel. No. 249867 (Dec. 15, 2020).

False revenue: In the Matter of Belden Inc., Adm. Proc. File No. 3-20169 (Dec. 14, 2020) is a proceeding which names the firm, a signal transmission solutions company, and its senior vice president of finance, Dennis Wiser, as Respondents. The case centers on the improper acceleration of revenue in 2017. Belden knew that there was a risk of improper acceleration at the company. In 2017 product was sold with the approval of Mr. Wiser, in a series of transactions were there was no reasonable chance it could be resold. It was not; then the product was returned. This occurred for $62 million of sales involving 140 transactions. The Order alleges violations of Securities Act Sections 17(a)(2) and (3) and Exchange Act Sections 13(a), 13(b)(2)(A), 13(b)(2)(B) and 13(b)(5). To resolve the proceedings each Respondent consented to the entry of a cease-and-desist order based on the Sections cited in the Order except the order as to the firm did not include Section 13(b)(5). Mr. Wiser was also denied the privilege of appearing and practicing before the Commission as an accountant with the right to reapply after three years. In addition, the company will pay a penalty of $650,000 while Mr. Wiser will pay $50,000. The funds will be transferred to the Treasury.

Unregistered broker: SEC v. Dobrovodsky, Civil Action No. 0:20-cv-62561 (S.D.Fla. Filed Dec. 14, 2020) is an action which names Roger Dobrovodsky as a defendant. Mr. Dobrovodsky acted as an unregistered broker for 1 Global Capital, LLC, a merchant cash advance company. Investors were told that the firm afforded them a good alternative to typical investments and that it was safe and paid good returns. Defendant was able to secure 60 transactions, earning $317,690 in commissions. In fact, the representations were false. The complaint alleges violations of Securities Act Sections 5(a) and 5(c) and Exchange Act Section 15(a)(1). The complaint is pending.

Share Class Selection: SEC v. CapWealth Advisors, LLC, Civil Action No. 3:20-cv-01064 (M.D. Tenn. Filed Dec. 11, 2020) is an action which names as defendants the registered investment adviser, its principal, Timothy Pagliara, and advisory representative Timothy Murphy. Over a three year period, beginning in June 2015, the firm failed to disclose that through its affiliated broker-dealer it was paid 12b-1 fees in connections with recommendations to purchase, hold or sell certain mutual fund shares. Defendants failed to make the required disclosures despite in disregard of their fiduciary duties. The complaint alleges violations of Advisers Act Sections 206(2) and 206(4). The case is pending. See Lit. Rel. No. 24986 (Dec. 15, 2020).

Impairment of good will: SEC v. Sequentrial Brands Group, Inc., Civil Action No. 1:20-cv-10471 (S.D.N.Y. Filed Dec. 11, 2020) names as a defendant the New York based brand management company. The firm was required to test the good will carried on its balance sheet each year. At the end of 2016 and at the end of 2017 the firm did calculations using the same method. Both reflected impairment. Yet the firm failed to take the appropriate write downs. Specifically, Sequentrial Brands utilized an alternate method which permitted the company to claim there was no impairment. Following those calculations, and despite clear evidence of impairment at the end of 2016 and during the first three quarters of 2017, the firm failed to take write downs of about $100 million. This resulted in a material understatement of expenses and understatement of Sequentrial Brands’ loss. The complaint alleges violations of Securities Act Section 17(a)(3) and Exchange Act Sections 13(a), 13(b)(2)(A) and 13(b)(2)(B). See also SEC v. Seth, Civil Action No. 0:20-cv-62563 (S.D.Fla. Filed Dec. 14, 2020)(names as a defendant Robert Seth who also participated in same scheme as an unregistered broker); SEC v. Walker, Civil Action No. 0:20-cv-62564 (S.D.Fla. Filed Dec. 14, 2020)(names as defendant Matthew Walker; based on same conduct as above). All of the cases are pending. See Lit. Rel. No. 24983 (Dec. 14, 2020).

Insider trading: SEC v. Clark, Civil Action No. 1:20-cv-01529 (E.D.Va. Filed Dec. 11, 2020) is an action which names as a defendant Christopher Clark and William Wright. The case centers on the acquisition of CEB Gartner, Inc., announced on January 5, 2017. Mr. Clark is the brother-in-law of Defendant Wright, the corporate controller of CEB. Between November 2016 and early January 2017 the two firms engaged in merger discussions. Mr. Clark, based on a tip from his brother-in-law, purchased options in advance of the announcement. After the announcement Mr. Clark sold his options, reaping profits of $243,190. Mr. Clark’s son, who was also tipped, sold his options, securing profits of $53,050. The case is pending. See Lit. Rel. No. 24982 (Dec. 11, 2020).

Court of Appeals

SARs: SEC v. Alpine Securities Corporation, No. 19-3272 (Decided Dec. 4, 2020). Alpine, a registered broker-dealer, was named as a defendant in an enforcement action by the Commission. The complaint alleged that the firm, which specializes in microcap securities, had failed over a period of time to properly file thousands of SARs either by not filing or by not properly furnishing the required information. The Commission’s complaint alleged violations of Exchange Act Section 17(a) and Rule 17a-8. Defendant responded by claiming that the Commission did not have the authority to enforce what are Bank Secrecy Act and FinCEN requirements. Specifically, Alpine asserted that the SEC does not have authority to bring an enforcement action based on a failure to file SARs under Section 17(a), that Rule 17a-8 is not valid and that the enactment of the Rule violated the Administrative Procedure Act. The District Court granted summary judgment in favor of the Commission. The Second Circuit affirmed.

The Court began with a brief review of the statutory authority for SARs. It traces to the Foreign Transactions Reporting Act of 1970, known as the Bank Secrecy Act, as amended by the PATRIOT Act in 2001. That Act required broker-dealers to file SARs after Treasury consulted with the SEC, the Board of Governors of the Federal Reserve and the Securities and Exchange Commission. The Treasury delegated that authority to the Financial Crimes Enforcement Network within the Treasury or FinCEN. In 2002 FinCEN promulgated regulations that require broker-dealers to file SARs with regard to certain transactions involving at least $5,000. The District Court rejected Defendant’s contention that the SEC did not have authority to bring this enforcement action and that the rules enacted requiring the filing of SARs hand not been promulgated in accord with the Administrative Procedure Act.

First, the Court quickly concluded that the Commission had the authority to initiate this enforcement action. The complaint was based solely on Exchange Act Section 17(a) and Rule 17a-8. Accordingly, the “suit falls within the SEC’s independent authority as the primary federal regulator of broker-dealers to ensure that they comply with reporting and recordkeeping requirements . . .” the Court found.

Second, the fact that Rule 17a-8 requires compliance with the Bank Secrecy Act requirements does not change this conclusion the Circuit Court stated. This question is governed by the analytical framework of Chevron v. Nat. Res. Def. Council, 467 U.S. 837 (1984). Under that decision if Congress has not specifically addressed the point and the statute is ambiguous, a reviewing court must respect the determination of the agency if it is permissible.

The determination of the agency in this action is tied to an express delegation by Congress of authority to determine “which reports from covered entities, including brokers and dealers are necessary and appropriate to further the goals of the Exchange Act. The Commission’s actions were undertaken in accord with the dictates of the statute. When enacting Rule 17a-8 the SEC concluded that the rule would protect national securities markets and exchanges. SARs, which assist the Treasury in targeting illegal securities transactions, also serve the aims of the Exchange Act by protecting investors and helping guard against market manipulation.

The fact that Congress directed Treasury to regulate record keeping and reporting by broker-dealers does not mean that the Commission is precluded from acting in the area as Defendant claims. To the contrary, as the Supreme Court held in FDA v. Brown & Williamson, 529 U.S. (2000) that result obtains only if there is a conflict. Here there is none. When Rule 17a-8 was first enacted the Commission noted in soliciting comments during the rule making that Treasury had delegated the responsibility to the Commission. No comments were filed. This is consistent with the fact that Congress did not silo SARs authority with Treasury, implying the SEC also has authority.

Finally, the Rule does not violate the APA as claimed by Defendant. Alpine’s argument is based on the fact that the Rule permits the automatic incorporation in the future of Bank Secrecy Act requirements in violation of the APA notice and comment rule making requirements. To the contrary, the public was afforded comment opportunities, the Court found. One occurred when the Commission published Rule 17a-8 since it expressly stated that it did “not specify the required reports and records so as to allow for any revisions the Treasury may adopt in the future.” When the Rule was formally adopted, the release reiterated this statement. When FinCEN later adopted its SARs rules, they were again subject to notice and comment by the public. There was thus “ample notice and comment opportunities in compliance with the APA,” the Court concluded.

Finally, in its most recent amendment to the Rule the Commission made it clear that it was consulting with FinCEN. The agency also made clear the fact that the Rule was consistent with the requirements of the Exchange Act. Based on this point, and the history of the Rule, the Court found that the requirements of the APA had been met.


Rules: The regulator proposed rules aimed at closing AML regulatory gaps for certain convertible, virtual currency, and digital asset transactions on December 18, 2020 (here).


Report: The Australian Securities and Futures Commission announced the results of its June 30, 2020 review of financial reports. The regulator reviewed the financial reports of 170 listed entities for the year ended June 30, 2020. The review was conducted as part of an ongoing risk-based review of financial reports (here).


Report: The European Securities and Markets Authority published draft technical standards under EMIR REFIT on December 17, 2020 (here). The standards deal with requirements for financial counterparties and their obligations o timely and accurately report OTC derivatives contracts.

Hong Kong

Proposals: The Securities and Futures Commission proposed amendments to the Code on Pooled Retirement Funds on December 18, 2020 (here). The regulator launched a three month consultation on the topic.


Facility: The Monetary Authority of Singapore announced the extension of the US $60 billion swap facility with the US federal reserve and the MAS – USD facility on December 17, 2020 (here).

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