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SEC awards whistleblower more than $10 million
On October 31, the SEC announced that it awarded a whistleblower more than $10 million for providing information and assistance that significantly contributed to a successful enforcement action. According to the redacted order, the whistleblower’s actions, including providing substantial information to the SEC and meeting twice with SEC staff, resulted in the return of a significant amount of money to harmed investors. “The charges in the covered action had a close nexus with the whistleblower’s allegations, which were critical to the underlying investigation,” the SEC said in the announcement, explaining that the action “illustrates how the Whistleblower Program works to benefit, via financial remediation, investors who are victimized by those who violate our securities laws.”
SEC says exchanges must have policies on incentive compensation given in error
On October 27, the SEC announced final rules requiring securities exchanges to adopt listing standards that require issuers to develop and implement policies providing for the recovery of erroneously awarded incentive-based compensation received by executive officers. The final rules require a listed issuer to file the policy as an exhibit to its annual report and to include disclosures related to its recovery policy and recovery analysis where a recovery is triggered. The SEC first proposed new rules for executive compensation disclosure in 2015, but they were not finalized. The SEC reopened consideration of the rules last year, and in August, adopted a new requirement that a reporting company’s proxy statement and other disclosures include a table showing executive compensation and financial performance measures.
According a statement released by SEC Chairman Gary Gensler, the new rules will “strengthen the transparency and quality of corporate financial statements, investor confidence in those statements, and the accountability of corporate executives to investors.” Commissioner Hester M. Peirce also released a statement, where she noted that implementing the statutory clawbacks mandate is “commendable,” but “doing it—expansively, inflexibly, and impractically—is not.” Peirce noted that the final rule “does not permit company boards, guided by their fiduciary duty, to determine when clawing back compensation makes sense,” and that “[s]uch an approach would have served shareholders by ensuring that companies claw back erroneously awarded compensation when doing so yields a net benefit to shareholders.” The final rules will become effective 60 days after publication in the Federal Register. Exchanges will be required to file proposed listing standards no later than 90 days following publication of the release in the Federal Register, with listing standards effective no later than one year following such publication.
Dems ask regulators to address crypto’s “revolving door”
On October 24, Democratic lawmakers sent letters to the leaders of the SEC, CFTC, Treasury Department, Federal Reserve, FDIC, OCC and CFPB regarding concerns about “the revolving door between [] financial regulatory agencies and the cryptocurrency (crypto) industry.” In the letters, the lawmakers argued “that the crypto revolving door risks corrupting the policymaking process and undermining the public’s trust in our financial regulators.” The letters also noted that Treasury saw the most movement from the Treasury Department, with 31 former employees joining the crypto industry. The SEC was second with 28 former employees, according to Tech Transparency Project. The lawmakers argued that “Americans should be able to trust that financial rules are crafted to reduce risk, improve security, and ensure the fair and efficient functioning of the market,” and that “Americans should be confident that regulators are working on behalf of the public, rather than auditioning for a high-paid lobbying job upon leaving government service.” The letters requested that the agencies provide information by November 7, including answers to inquiries about each agency’s ethics guidelines and polices in place to protect the agency from being influenced by current or former employees’ potential conflicts of interest.
Senator urges SEC to issue crypto rulemaking
On October 13, Senator John Hickenlooper (D-CO) sent a letter to SEC Chair Gary Gensler urging him to issue regulations on digital asset securities. According to the letter, Hickenlooper urged the agency to publish regulations through a notice-and-comment process, stating that “existing laws and regulations were not designed to deal with how digital assets are being used in the market.” Hickenlooper noted that the SEC has repeatedly mentioned that existing securities regulations do not ‘cleanly apply’ to digital securities and said that retail investors may not always receive proper disclosures for comprehending the risks tied to digital assets. Hickenlooper also commented that “there are some products and investments, such as Initial Coin Offerings (ICOs), where the SEC is well positioned to offer regulatory guidance since ICOs operate similarly to a traditional financial product.” He specifically urged the SEC to, among other things, clarify what types of digital assets are securities, address how digital securities should be issued and listed, determine what disclosures are necessary for investors to be properly informed, and establish a registration regime for digital asset security trading platforms.
SEC amends electronic recordkeeping requirements for security-based swap entities
On October 12, the SEC adopted final amendments to its rule governing the electronic recordkeeping requirements for security-based swap entities. (See SEC fact sheet here.) The updates are applicable to security-based swap dealers (SBSDs) and major security-based swap participants (MSBSPs), and are intended to make the rule adaptable to new technologies in electronic recordkeeping. The amendments will also facilitate examinations of broker-dealers, SBSDs, and MSBSPs by “designating broker-dealer examining authorities as Commission designees for purposes of certain provisions of the broker-dealer record maintenance and preservation rule,” the SEC said. Specifically, the amendments address requirements related to the maintenance and preservation of electronic records, the use of third-party recordkeeping services to hold records, and the prompt production of records. Under the SEC’s broker-dealer electronic recordkeeping rule, broker-dealers are required “to preserve electronic records exclusively in a non-rewriteable, non-erasable format,” known as the “write once, read many format.” The amendments now provide an audit-trail alternative under which broker-dealers “must preserve electronic records in a manner that permits the recreation of an original record if it is altered, over-written, or erased.” According to the SEC’s announcement, the audit-trail alternative is intended to provide broker-dealers greater flexibility when configuring their electronic recordkeeping systems so they more closely align with current electronic recordkeeping practices, while also ensuring that the authenticity and reliability of the original records are protected. The amendments are also applicable to nonbank SBSDs and MSBSPs.
The final amendments are effective 60 days after publication in the Federal Register.
SEC accuses crypto companies of $37 million scheme
On September 30, the SEC filed a complaint in the U.S. District Court for the Southern District of Florida against two cryptocurrency companies and their principals (collectively, “defendants”) claiming that they falsely promised investors that their cryptocurrency was backed by a $10 billion gold bullion investment. According to the complaint, the SEC alleged that between May 2018 and January 2019, the defendants “made material misrepresentations and omissions to investors while they were offering and selling [a crypto asset that the companies owned and controlled] in a series of news and press releases issued to the public." The releases falsely claimed that one of the cryptocurrency companies had acquired and received title to $10 billion in gold bullion and intended to back each token that was owned and controlled by the companies issued and sold to investors with $1.00 worth of this gold. One of the companies claimed to have acquired the gold through a purchase transaction with one of the principles and his company. The defendants also misrepresented that independent accounting firms had performed an “audit” of the gold and verified its existence. In reality, the gold acquisition transaction was a sham. The SEC’s complaint alleged violations of anti-fraud and securities registration provisions of the federal securities laws. The SEC is seeking permanent injunctive relief, disgorgement plus prejudgment interest, civil penalties and officer-and-director bars against the individual defendants.
SEC files charges against crypto-asset seminar operation
On September 19, the SEC filed a complaint against a two individuals and the companies they controlled (collectively, “defendants”) in the U.S. District Court for the Southern District of Texas for allegedly operating an on-going fraudulent and unregistered crypto-asset offering targeting Latino investors. According to the SEC, the defendants allegedly raised more than $12 million from over 5,000 investors who paid for seminars to learn how to build wealth through crypto-asset trading. However, the SEC claimed that one of the individual defendants—who founded the company and actually had no education or training in investments or crypto assets—used the seminars to solicit investors to give their money to the company and then supposedly used the funds to conduct crypto asset and foreign exchange trading. In total, the SEC alleged the individual defendants made roughly $2.7 million in Ponzi payments, diverting nearly $8 million for their own personal use. The complaint charges the defendants with violating, or aiding and abetting violations of, the antifraud provisions of the Securities Act of 1933, the Securities Exchange Act of 1934, and the Securities Act. The company’s founder is also charged with violating the Investment Advisers Act of 1940. The complaint seeks a permanent injunction against the defendants, civil penalties, disgorgement of ill-gotten gains with prejudgment interest, and bars. The SEC stated in its announcement that, at the Commission’s request, the court issued a temporary restraining order to stop the offering, in addition to temporary orders freezing assets and granting additional emergency relief.
SEC charges celebrity with unlawfully promoting crypto security
On October 1, the SEC announced charges against a celebrity (respondent) who allegedly used her social media accountg to tout a crypto-asset security without disclosing the payment she received for the promotion. According to the SEC’s order, the respondent promoted the crypto-asset security on her social media account in exchange for financial payment from the issuer, receiving approximately $250,000 for the promotion. Specifically, the respondent posted a link to a securities offering conducted by an online company with a public website, in which it offered and sold digital tokens to the public. The tokens were offered and sold as investment contracts and therefore qualified as securities pursuant to Section 2(a)(1) of the Securities Act. The SEC’s order found that the respondent violated the anti-touting provision of the federal securities laws. Without admitting or denying the SEC’s findings, the respondent agreed to pay $1.26 million, including approximately $260,000 in disgorgement, which represents her promotional payment, plus prejudgment interest, and a $1,000,000 penalty. The respondent also agreed to not promote any crypto-asset securities for three years.
SEC orders global accounting firm’s Chinese affiliate to pay $20 million for auditing failures
On September 29, the SEC issued a cease and desist order against the Chinese affiliate of a global accounting firm for allegedly failing to comply with U.S. professional auditing requirements when conducting component audits of U.S. issuers and auditing foreign companies listed on U.S. exchanges. According to the SEC, during the course of numerous audits, personnel at the Chinese affiliate allegedly, among other things, asked clients to choose their own samples for testing and complete required audit documentation purportedly showing that the Chinese affiliate had obtained and assessed supporting evidence for certain clients’ accounting entries. This was allegedly done in order to create the illusion that the required testing of clients’ financial statements and internal controls had been conducted when there was allegedly no evidence that it had in fact happened. The SEC noted that the alleged misconduct involved both junior and senior audit team members and demonstrated a lack of supervision by audit partners. Moreover, the Chinese affiliate’s alleged failure to follow required Public Company Accounting Oversight Board (PCAOB) auditing standards created a significant threat to U.S. investors.
“While the SEC’s action today does not implicate a violation of the Holding Foreign Companies Accountable Act, the action does underscore the need for the [PCAOB] to be able to inspect Chinese audit firms,” SEC Chair Gary Gensler said in the announcement. “A fundamental goal of the PCAOB’s inspection regime is to identify weaknesses in the firms’ quality control processes—the very weaknesses at issue in this case.”
Without admitting or denying the allegations, the Chinese affiliate agreed to settle the charges by paying a $20 million civil money penalty and implementing extensive remedial measures, including completing a review and assessment of its policies and procedures by an independent consultant and implementing a course of action to address identified deficiencies. Audit professionals at the Chinese affiliate who serve U.S. public company audit clients are also required to undertake additional training.
FSOC reports on cryptocurrency systemic risks
On October 3, the Financial Stability Oversight Council (FSOC) released its Report on Digital Asset Financial Stability Risks and Regulation. As called for by Executive Order 14067, “Ensuring Responsible Development of Digital Assets” (covered by InfoBytes here), the report reviewed financial stability risks and regulatory gaps posed by various types of digital assets and provided recommendations to address such risks. Among other things, the report noted three gaps in the existing cryptocurrency regulatory framework: (i) limited direct federal oversight of the spot market for crypto-assets that are not securities; (ii) opportunities for regulatory arbitrage; and (iii) whether vertically integrated market structures can or should be accommodated under existing laws and regulations. The report stated that FSOC recommended that Congress pass legislation that would create “a comprehensive prudential framework for stablecoin issuers that also addresses the associated market integrity, investor and consumer protection and payments system risks, including for entities that perform services critical to the functioning of the stablecoin arrangement.” FSOC further recommended that the member agencies should follow several guiding principles, including “same activity, same risk, same regulatory outcome,” and “technology neutrality.” The report also requested that agencies consider whether “vertical integration” or other business models where retail customers can directly access markets instead of going through a broker-dealer “can or should be accommodated.” The report noted that if banks “scale up their participation in the crypto-asset ecosystem, such activity could potentially entail much greater access to the crypto-asset market by a broad range of institutional investors, corporations, and retail customers than currently exists.” The U.S. Treasury Department released a Fact Sheet summarizing the report’s key findings and recommendations.
Treasury Secretary Janet Yellen noted in a statement that the “report adds to analysis of digital asset issues that have been covered in other recent reports, including on the future of money and payments; consumers and investor protection; illicit finance; and a framework for international engagement.” Acting Comptroller of the Currency Michael J. Hsu released a statement supporting the report, emphasizing that “it is critical for the Council and Congress to prioritize Recommendation 4 regarding interagency coordination, Recommendation 5 regarding a federal prudential framework for stablecoin issuers, and Recommendation 6 regarding regulatory visibility and authorities over all of the activities of crypto-asset entities.” SEC Chair Gary Gensler also expressed his support in a statement, noting that he looks “forward to working with Congress to achieve our public policy goals, consistent with maintaining the regulation of crypto security tokens and related intermediaries at the SEC.” Texas Banking Commissioner and FSOC state banking representative Charles G. Cooper released a statement of support through the Conference of State Bank Supervisors saying that the report should “inform the work that we do as individual agencies and on an interagency basis to balance responsible innovation with safeguarding our financial markets and consumers.”CFPB Director Rohit Chopra released a statement, noting that “agencies have already taken steps to address discrete issues related to deposit insurance misrepresentation and to lay groundwork to address concerns related to fraud, hacks, and scams,” and emphasized the need “to tackle broader risks to the financial system.”