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  • SEC targets crypto developer and influencer for sale of unregistered securities

    Securities

    On September 19, the SEC issued a cease and desist order against a software development company and its founder (collectively, “respondents”) for the unregistered offer and sale of crypto asset securities. The SEC also announced charges against a crypto influencer involved in promoting the company. According to the SEC’s order, from April 2018 into July 2018, the respondents allegedly conducted an unregistered securities offering of crypto asset securities, which raised approximately $30 million from nearly 4,000 investors. The SEC noted that the respondents told investors that the crypto asset securities would raise in value, that the company’s management would continue to improve the company, and that they would make the tokens available on a crypto trading platform. The order also found that the crypto asset securities were not registered with the SEC and were not applicable for a registration exemption. The SEC alleged the respondents violated the offering registration provisions of Sections 5(a) and 5(c) of the Securities Act of 1933.

    According to the SEC’s complaint against the influencer, which was filed in the U.S. District Court for the Western District of Texas, the influencer purchased $5 million worth of the company’s crypto asset securities and promoted it on social media platforms from approximately May 2018 to July 2018. He also allegedly failed to disclose that the company had agreed to provide him a 30 percent bonus on the tokens that he purchased, as consideration for his promotional efforts. Additionally, the SEC alleged that he also organized an investing pool, despite not registering the offering with the SEC. The complaint alleged violations of the offering registration provisions of Section 5(a) and (c) of the Securities Act, as well as violations of Section 17(b) of the Act, and seeks injunctive relief, disgorgement plus prejudgment interest, and civil penalties.

    Without admitting or denying the allegations, the company agreed to pay $30 million in disgorgement, $4 million in prejudgment interest, and a $500,000 civil penalty. The company also agreed to destroy its remaining tokens, request the removal of its tokens from trading platforms, and publish the SEC’s order on its website and social media channels. The founder, without admitting or denying the SEC’s findings, agreed to refrain from participating in offerings of crypto asset securities for a period of five years and will pay a $250,000 civil penalty.

    Securities Enforcement SEC Digital Assets Cryptocurrency Securities Act

  • CFTC commissioner pushes for wrongdoing admissions in settlements

    Securities

    On September 19, CFTC Commissioner Christy Goldsmith Romero called on the agency to adopt her proposed Heightened Enforcement Accountability and Transparency (HEAT) Test, which would require defendants to admit wrongdoing in CFTC enforcement settlements. Expressing “deep concerns” with the CFTC’s practice of not seeking admissions of wrongdoing when settling the majority of enforcement cases (thus resulting in a majority of settlements where the defendant “neither admits nor denies” wrongdoing), Romero stressed that she does not support allowing defendants to settle without admitting their illegal conduct. Romero’s proposed HEAT Test would, among other things, (i) require defendants to acknowledge responsibility and wrongdoing to the public in cases where heightened accountability and acceptance of responsibility are in the public interest; (ii) require more defendants to admit their wrongdoing, thus maximizing public accountability, increasing transparency of a defendant’s wrongdoing, and heightening the deterrent impact of the agency’s enforcement settlements; and (iii) assist the CFTC in reviewing cases that may call for heightened scrutiny of these factors. Romero added that the CFTC should be more willing to take cases to trial when defendants are not willing to admit wrongdoing.

    Securities CFTC Enforcement Settlement

  • SEC proposes new rules for clearing agencies

    Securities

    On September 14, the SEC announced a proposed rule regarding risk management practices for central counterparties in the U.S. Treasury Department market. Among other things, the proposed rule would update the membership standards required of covered clearing agencies for the Treasury market with respect to a member’s clearance and settlement of specified secondary market transactions. Specifically, the proposal would require that clearing agencies in the U.S. Treasury market adopt policies and procedures designed to require their members to submit for clearing certain specified secondary market transactions, which would include: “all repurchase and reverse repurchase agreements collateralized by U.S. Treasury securities entered into by a member of the clearing agency; all purchase and sale transactions entered into by a member of the clearing agency that is an interdealer broker; and all purchase and sale transactions entered into between a clearing agency member and either a registered broker-dealer, a government securities broker, a government securities dealer, a hedge fund, or a particular type of leveraged account.” According to a statement by SEC Chair Gary Gensler, the proposed rule would “reduce risk across a vital part of our capital markets in both normal and stress times.” The SEC also released a Fact Sheet providing more information on the proposal. Comments are due 60 days after publication in the Federal Register.

    Securities Agency Rule-Making & Guidance SEC Department of Treasury Federal Register Risk Management

  • SEC opens crypto assets office

    Securities

    On September 8, SEC Chair Gary Gensler issued remarks before the Practising Law Institute to discuss cryptocurrency tokens and corresponding SEC regulation. During his remarks, Gensler stated his view that the “vast majority” of cryptocurrency tokens on the market are securities that are subject to SEC regulation. As a result, investors in cryptocurrencies “deserve disclosure to help them sort between the investments that they think will flourish and those that they think will flounder,” and that the law requires such protections. Gensler, also addressed stablecoins, which he also concluded raised significant policy issues. Gensler pointed out that depending on their attributes, stablecoins “may be shares of a money market fund or another kind of security,” and therefore require registration and deserve investor protections. Finally, addressing crypto intermediaries, Gensler noted that they are either engaging “in the business of effecting transactions in crypto security tokens for the account of others, which makes them brokers, or engage in the business of buying and selling crypto security tokens for their own account, which makes them dealers.” He warned that because crypto intermediaries often commingle other functions with a market, investors are inherently exposed to conflicts of interest and risks. To address this, Gensler noted that he encouraged SEC staff to collaborate “with intermediaries to ensure they register each of their functions—exchange, broker-dealer, custodial functions, and the like—which could result in disaggregating their functions into separate legal entities to mitigate conflicts of interest and enhance investor protection.” Gensler noted that legislation should be crafted in a way that maintains the SEC’s oversight of crypto security tokens, and added that these kind of assets make up most of the digital assets that are currently traded.

    The same week, the SEC announced it is establishing an Office of Crypto Assets and an Office of Industrial Applications and Services to the Division of Corporation Finance’s Disclosure Review Program (DRP), which “has long had offices to review company filings by issuers.” According to the SEC, the offices will join the seven existing offices that provide focused review of issuer filings to continue the SEC’s efforts in promoting capital formation and protecting investors. The Office of Crypto Assets will permit “the DRP to better focus its resources and expertise to address the unique and evolving filing review issues related to crypto assets.”

    Securities Digital Assets Federal Issues Cryptocurrency Stablecoins Virtual Currency SEC Fintech

  • SEC warns Chinese companies against switching auditors to avoid compliance

    Securities

    On September 6, SEC acting Chief Accountant Paul Munter issued a warning to Chinese companies that they may face enforcement actions if they switch auditing firms to remain listed in the U.S. that do not follow applicable standards. Munter pointed to instances of foreign issuers, especially those located in China or Hong Kong, “changing their lead auditor from a local registered public accounting firm to a registered public accounting firm located either in the U.S. or elsewhere, generally within the same network.” According to Munter, these types of arrangements create “special challenges that raise questions about whether the newly engaged registered public accounting firms—whether located in the U.S. or elsewhere—will be able to satisfy their responsibilities to serve as the lead auditor.” Munter noted that the U.S. Public Company Accounting Oversight Board (PCAOB), the China Securities Regulatory Commission, and the Ministry of Finance of the People’s Republic of China, recently signed a Statement of Protocol governing inspections and investigations of audit firms based in China or Hong Kong. He said, however, that certain issuers based in China and Hong Kong have started structuring audits with registered public accounting firms located either in the U.S. or elsewhere “to avoid the potential of consecutive PCAOB [Holding Foreign Companies Accountable Act] determinations and a potential resultant trading prohibition.” Issuers and firms looking to avoid compliance could result in investigations and enforcement actions by the PCAOB, the SEC, or both.

    Securities Agency Rule-Making & Guidance Financial Crimes China Audit

  • SEC releases draft regulatory strategic plan

    Securities

    Recently, the SEC released its draft FY 2022-2026 strategic plan, which focuses on goals related to protecting families against fraud and misconduct, supporting a diverse and inclusive workforce, and developing a regulatory framework that keeps pace with ever-evolving markets, business models, and technologies. The SEC noted that it plans to continue to update its disclosure framework to meet investors’ demands for information related to issuers’ climate risks and cybersecurity hygiene policies to ensure informed investment decisions are made. The draft strategic plan also discussed market risks associated with cybersecurity threats and cross-border challenges, and called on the SEC to coordinate with foreign financial regulators. The SEC also stated it plans to update existing rules and approaches to better “reflect evolving technologies, business models, and capital markets,” and intends to examine strategies for addressing systemic and infrastructure risks faced by capital markets and market participants.

    Securities Agency Rule-Making & Guidance Privacy, Cyber Risk & Data Security Fintech

  • SEC files charges in undisclosed transactions case

    Securities

    On August 30, the SEC filed a complaint against two North Carolina-based executives, and their Malta-based registered investment adviser company (collectively, “defendants”) in the U.S. District Court for the Middle District of North Carolina for allegedly engaging in a fraudulent scheme involving undisclosed transactions. According to the SEC, the defendants “repeatedly recommended and entered into transactions that were not disclosed to and were not in the best interests of their clients.” Specifically, one of the executives allegedly “acquired 100% ownership of four North Carolina insurance companies [] and a reinsurance trust, which gave him control over hundreds of millions of dollars in premiums from their policyholders.” The complaint further stated that “[a]lthough the funds were supposed to be used to pay the policyholders’ insurance claims, [the executive] treated the funds as his own assets and used the money for any purpose he decided was in his best interest.” The SEC found that the executive allegedly conducted the schemes through “complex” investment structures and affiliate companies and allegedly used the proceeds to pay himself or to divert the funds to his other businesses. The complaint also noted that the defendants “breached their fiduciary duties to their advisory clients by engaging in numerous undisclosed related-party transactions and by misappropriating over $57 million in client funds” and over $21.4 million in advisory fees generated in connection with these schemes. The SEC’s complaint alleged violations of anti-fraud provisions of the Investment Advisers Act of 1940. The complaint seeks a permanent injunction against the defendants, disgorgement of ill-gotten gains, penalties, bars, and other equitable relief.

    Securities SEC Enforcement Transactions Investment Advisers Act Courts

  • SEC amends whistleblower rules

    Securities

    On August 26, the SEC adopted two amendments to its whistleblower program rules, which will expand the circumstances in which the Commission can pay whistleblowers for their information and assistance in connection with non-SEC actions, and affirms the Commission’s authority to consider the dollar amount of a potential award for the purposes of increasing, but not decreasing, an award. Specifically, the final rule amends Rule 21F-3 to allow the SEC “to pay whistleblower awards for certain actions brought by other entities, including designated federal agencies, in cases where those awards might otherwise be paid under the other entity’s whistleblower program.” The expanded circumstances contemplated by the SEC include instances “when the other [federal] entity’s program is not comparable to the [SEC]’s program or if the maximum award that the [SEC] could pay on the related action would not exceed $5 million.” The final rule also amends the SEC’s authority under Rule 21F-6 to ”affirm the [SEC]’s authority … to consider the dollar amount of a potential award for the limited purpose of increasing the award.” The amendment “eliminate[s] the [SEC]’s authority to consider the dollar amount of a potential award for the purpose of decreasing the award.” SEC Chair Gary Gensler stated that the amendments “will strengthen [the SEC’s] whistleblower program.” Commissioner Hester M. Peirce in contrast said that while the amendments are “inconsequential” to the success of the whistleblower program, they “carry harmful consequences both for the whistleblower program and for the [SEC]’s rulemaking processes” and “further complicate the already byzantine rules governing [the SEC’s] whistleblower program.”

    Securities SEC Whistleblower Agency Rule-Making & Guidance

  • SEC fines bank $1.7 million over misstating value of real estate loans

    Securities

    On August 24, the SEC issued a cease and desist order to a bank for allegedly misstating representations regarding the securitization of commercial real estate (CRE) loans. According to the order, from the first quarter of 2017 to the first quarter of 2019, the respondent bank made filings with the SEC in which it reported gains that it received from the sales of loans included in five CRE securitizations. Among other things, the SEC alleged that the bank: (i) “failed to document adequately and incorporate all reasonably available market data into its valuation assumptions for the CRE certificates” it received as consideration in the CRE securitizations, and (ii) “omitted and misstated material information related to the certificates and the assumptions that it had used in valuing those certificates in certain of its quarterly and annual financial statements.” The SEC noted that the bank allegedly improperly used unreasonably low assumptions for the prepayment risks applicable to the CRE certificates. In particular, the SEC alleged that the bank used baseline prepayment assumptions of 0 percent or 5 percent constant prepayment yields (CPY) while not properly documenting why other approaches were not adopted, such as the existing convention of using 100 CPY, or using available market research which indicated comparable loans generally exceeded 30 percent CPY. Without admitting or denying the allegations, the bank agreed to pay a $1.75 million civil penalty. The company will also cease and desist from committing or causing any future violations of the Exchange Act.

    Securities Enforcement SEC Real Estate Securities Exchange Act Commercial Lending

  • District Court approves class action settlement against securities trading platform and broker-dealer

    Courts

    On May 16, the U.S. District Court for the Northern District of California granted final approval of a settlement in a class action against a securities trading platform and broker-dealer (defendant) for allegedly allowing unauthorized users access to customers’ accounts. As described in plaintiffs’ motion for preliminary approval of settlement, class members alleged the defendant “lacked security measures used by other broker-dealer online systems,” which allowed “thousands of [the defendant’s] customer accounts [to be] accessed by unauthorized users.” Based on these allegations, class members brought claims for negligence, breach of contract, and violations of various state consumer privacy, competition, and advertising laws. Under the terms of the settlement, the defendant must provide cash payments of up to $260 each to settlement class members who submit a claim, up to a total amount of $500,000. Additionally, among other things, the defendant must “provide two years of credit monitoring and identity theft protection services to those who elect to receive it,” must “maintain improvements to its security protocols and policies to decrease the risk of unauthorized access to its customers’ accounts,” and must “respond effectively to instances of potential unauthorized access” in the future.

    Courts Privacy, Cyber Risk & Data Security Class Action Data Breach Securities

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