This Week In Securities Litigation (Week of Feb. 22, 2021)
GameStop continued to be the topic de jure last week with hearings on Capitol Hill before a Congressional Committee. The key players were present, including the founder of Robinhood. Each appeared and testified.
While the hearings made for interesting media at times, little appeared to have been accomplished beyond the usual theatrics. If improvements to the trading system are going to evolve from this incident look for them to come from the report the SEC will issue in due course.
Be careful, be safe this week
Whistleblowers: The Commission awarded almost $3 million in two separate awards to whistleblowers who aided enforcement.
SEC Enforcement – Filed and Settled Actions
The Commission filed 3 new civil injunctive actions and no administrative proceedings last week, excluding 12j, tag-along proceedings and other similar matters.
Crypto – coins: SEC v. Coinseed, Inc., Civil Action No. 1:21-cv-01881 (S.D.N.Y. Filed Feb. 17, 2021) is an action which names as defendants the firm and Delerdalai Davaasambuu, respectively, a New York city based firm formed in 2017 and a citizen of Mongolia, residing in New York City, who founded Coinseed. Over a period of about 5 months, beginning in late 2017 shortly after the founding of Coinseed, Defendants offered and sold tokens called CSD to the public. Purchasers were told they would receive a percentage of revenues from certain fees generated by the business. Investors were also told that their funds would be used to develop the firm’s business which supposedly included a mobile phone application that would enable users to purchase and sell digital assets and to pay other business expenses. About $141,000 was raised from the sales. There was no registration statement in effect. The complaint alleges violations of Securities Act Sections 5(a) and 5(c). The case is pending. See Lit. Rel. No. 25032 (Feb. 17, 2021).
Offering fraud: SEC v. Cimino, Civil Action No. 7:21-cv-01375 (S.D.N.Y. Filed Feb. 17, 2021) is an action which names as a defendant Joseph Cimino, the founder of 6 Degree Tequila, LLC, a private company that sells a tequila made in Mexico. Over a period of about 3 years, beginning in late 2014, Defendant raised about $985,0000 from 24 investors as start-up money for the firm. Specifically, investors were furnished with what they were told was a list of people who had invested in the company. The list made it appear that the company had more investors and had raised more money than in fact it had been able to do. Defendant also misappropriate part of the money raised. The complaint alleges violations of Securities Act Section 17(a) and Exchange Act Section 10(b). The case is pending. See Lit. Rel. No. 25031 (Feb. 17, 2021).
Controls: SEC v. Morningstar Credit Ratings, LLC, No. 1:21-cv-01359 (S.D.N.Y. Filed February 16, 2021). Morningstar is a New York City based nationally recognized statistical ratings organization. Its parent’s shares – Morningstar, Inc. — are traded on Nasdaq Global Select Market. This action centers on ratings for $30 billion of commercial mortgage-backed securities for 30 transactions. The ratings and transactions span a two-year period beginning in 2015. Morningstar used a two-step process to prepare the ratings. The first step focused on key cash flow and valuation amounts for the properties and associated values backing the securities. The second employed a subordination process and model. The results from the two steps, each of which were disclosed, spawned the ratings. Those ratings are viewed as a crucial step in the sales process for the “certificates” issued on the securities. In the first step, the company underwrote a representative sample of the pool of commercial real estate loans that collateralized each CMBS transaction. Morningstar calculated the expected net cash flow that each commercial property would generate over the life of the loan. This step was disclosed and published on the firm’s website. The second step – the subordination step and model – was also disclosed on the website. Here the cash flow and the capitalization rate were put on an excel spreadsheet. The Subordination Model was used to subject the values to what are called “defined sets of stresses.” The point was to determine the likelihood of default under select stresses. The result is expressed as a percentage. What was not disclosed were certain loan specific adjustments made during step two of the process. The adjustments were made on the excel spreadsheet that reflected the model used in the step. There was no guidelance to direct the analyst making the adjustments. The model did not constrain how the analyst made the adjustments or the size. The loan specific adjustments had a material impact. Most of the adjustments decreased the stress. The result was an increase in the rating. Overall the net impact was that “investors were not able to assess the ratings determined by Morningstar and their associated risks.” The ratings that resulted from the process were, however, beneficial to those who paid for them. The firm failed to disclose the adjustments or identify them on forms filed with the Commission. Morningstar also did not have effective internal controls regarding the use of the loan-specific adjustments. The complaint alleges violations of Exchange Act Section 15E(b)(2) and Rule 17g-1(f).
Remarks: Sean Hughes, Commissioner, ASIC, delivered remarks to the Australian Finance Industry Association Risk Summit on February 16, 2021. The Commissioner’s remarks focused on the impact of recent stress on the financial system and its resilience (here).
Remarks: Ashley Alder, Director of the Securities and Futures Commission, delivered the key note speech at the Climate Risk and Green Finance Regulatory Forum 2021. His remarks were titled Climate Change and Finance: What’s Next for Global Regulators? It was delivered on February 18, 2021. Speaking as the head of the International Organization of Securities Commissions, the regulator’s remarks focused on a series of climate related subjects including the need for good disclosures by companies to facilitate investor choices (here).
Consultation paper: The Monetary Authority of Singapore published a consultation paper on Proposed Revisions to Enterprise Risk Management, Investment and Public Disclosure Requirements for Insurers. The paper, published on February 19, 2021, details the regulators proposals for enterprise risk management for issuers (here).