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SEC files charges in undisclosed transactions case
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.
SEC amends whistleblower rules
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.”
SEC fines bank $1.7 million over misstating value of real estate loans
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.
District Court approves class action settlement against securities trading platform and broker-dealer
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.
SEC publishes amendments on disclosures failures
On August 25, the SEC announced proposed amendments to its rules requiring registrants to disclose information reflecting the relationship between executive compensation actually paid by a registrant and the registrant’s financial performance. According to the final rule, registrants would be required to provide a table disclosing specified executive compensation and financial performance measures for their five most recently completed fiscal years. In regard to the measures of performance, a registrant will be required to report its total shareholder return (TSR), the TSR of companies in the registrant's peer group, its net income, and a financial performance measure chosen by the registrant. Using the information presented in the table, registrants will be required to disclose the relationships between the executive compensation actually paid and each of the performance measures, as well as the relationship between the registrant’s TSR and the TSR of its selected peer group. Specifically, large companies would be required to disclose details on executive compensation for the past five fiscal years, and small companies would be required to report the past three fiscal years. Additionally, small companies would be exempt from disclosing details on pensions and peer groups. They also are exempt from new language requiring companies to list the three to seven most important measures linking executive compensation to company performance. Emerging growth companies, registered investment companies, and foreign private issuers are not required to provide the disclosure. The final rules are effective 30 days after publication in the Federal Register, and registrants must comply with the new disclosure requirements in proxy and information statements that are required for fiscal years ending on or after December 16. The same day, the SEC published a fact sheet clarifying, among other things, the final rules implementing the pay versus performance requirement as required by Congress in the Dodd-Frank Act.
DFPI orders crypto lender to cease offering unqualified securities
On August 8, the California Department of Financial Protection and Innovation (DFPI) issued a desist and refrain order to a now-bankrupt cryptocurrency lender and its CEO after determining that the company allegedly made material misrepresentations and omissions in the offering of crypto interest accounts, particularly with respect to understating the risks of depositing digital assets with the company. According to DFPI, since June 2018, the company funded part of its lending operations and proprietary trading through the sale of unqualified securities in the form of digital asset interest-earning accounts known as “Earn Rewards” accounts. DFPI found that the company allegedly offered these accounts to consumers without first qualifying them as securities in compliance with California’s Corporate Securities Law. Additionally, DFPI contended that the company failed to fully disclose material aspects of its business and Earn Rewards accounts, and claimed that the CEO failed to disclose material aspects of the company’s business, made materially misleading statements, or omitted material facts necessary to ensure the statements were not misleading. In June, the company suspended the fulfillment of customer withdrawals from its crypto interest accounts and filed for Chapter 11 bankruptcy reorganization on July 13.
DFPI ordered the company and CEO to desist and refrain from further offers and sale of securities in California, including but not limited to the Earn Rewards accounts, unless such sale has been qualified under California law or unless the security or transaction is exempt from qualification. The company and CEO were also both ordered to desist and refrain from offering securities in California by means of untrue statements of material fact or omissions of material fact.
SEC files charges against investment scheme targeting seniors
On August 17, the SEC filed a complaint against an consulting company and its owner (collectively, “defendants”) in the U.S. District Court for the District of New Jersey for allegedly making materially false and misleading statements and omitting material facts regarding a fraudulent investment scheme. According to the SEC, between February 2017 to May 2022, the owner offered and sold securities in the form of promissory notes issued by the company to at least eleven investors, ages 64 to 82, raising at least $1.2 million while promising interest rates ranging from 50 percent to 175 percent. The owner allegedly “falsely represented to at least certain of the investors that, among other things, the money they invested in the [company] would be used to make loans to other businesses, which would generate the profits used to repay the [company].” As part of the scheme, the owner is alleged to have provided conflicting explanations of the company’s business and convinced investors “to roll-over their notes into new notes combining unpaid amounts with new investments.” The SEC further alleged that instead the owner withdrew over $486,000 from the company’s bank account and used it to fund his lifestyle and pay for personal expenses. The SEC’s complaint alleges violations of the antifraud provisions of the federal securities laws, specifically, the Securities Act of 1933 and the Securities Exchange Act of 1934. The complaint seeks a permanent injunction against the defendants, disgorgement of ill-gotten gains, plus interest, penalties, bars, and other equitable relief.
SEC files charges in brokerage hacking case
On August 15, the SEC filed a complaint against 18 individuals and entities (collectively, “defendants”) in the U.S. District Court for the Northern District of Georgia for allegedly engaging in a fraudulent scheme in which online retail brokerage accounts were hacked and improperly used to purchase microcap stocks. According to the SEC, the defendants collectively acquired substantial shares of the common stock of two public microcap companies. After obtaining the shares, some defendants conspired with other unknown parties to subject various retail brokerage accounts, held by third-party investors, to online account takeover attacks. The hacked accounts then were forced to make large purchases of the companies’ common stock, thereby artificially inflating the trading price and volume of the stocks. The defendants then sold the shares they had acquired at the inflated prices, generating approximately $1.3 million in proceeds and creating substantial profits for the defendants. The complaint also noted that throughout the scheme, some defendants repeatedly took steps to conceal their beneficial ownership of the company’s shares by, among other things, failing to file with the Commission certain beneficial ownership reports required by law. The SEC’s complaint alleges violations of anti-fraud and beneficial ownership reporting provisions of the federal securities laws, specifically, the Securities Act of 1933 and the Securities Exchange Act of 1934. The complaint seeks a permanent injunction against the defendants, disgorgement of ill-gotten gains, plus interest, penalties, bars, and other equitable relief. According to the SEC Director of Division of Enforcement, the case “illustrates the critical importance of cybersecurity and of our ongoing efforts to protect retail investors from cyber fraud.”
CFTC alleges crypto promoter’s digital asset trading scheme violates CEA
On August 12, the CFTC filed charges against an individual and his two Ohio-based cryptocurrency promotion companies for allegedly violating the Commodity Exchange Act and Commission regulations by soliciting more than $1 million in a digital asset trading scheme. The complaint alleged that the defendants made false and misleading statements in their solicitations to customers, including profit guarantees and claims concerning the individual defendant’s supposed success as a digital asset trader. According to the complaint, customers were guaranteed that they would not lose their initial investment and would be able to withdraw their initial investment and alleged profits at any time; however, defendants allegedly refused to allow existing customers to withdraw these funds, stopped communicating with customers, and manufactured excuses as to why funds were not returned. The complaint also contended, among other things, that the defendants omitted material facts, including that the defendants “misappropriated customer funds to pay purported profits to other customers in a manner akin to a Ponzi scheme,” misappropriated customer funds to pay for the individual defendant’s lifestyle, and commingled customer funds with personal bank and digital asset trading accounts. The CFTC seeks: (i) restitution for defrauded investors; (ii) disgorgement; (iii) civil monetary penalties; (iv) permanent registration and trading bans; and (v) a permanent injunction from future violations.
SEC issues more than $16 million in whistleblower awards
On August 9, the SEC announced whistleblower awards totaling more than $16 million to two whistleblowers for providing information and assistance in a successful SEC enforcement action. According to the redacted order, the SEC awarded approximately $13 million to one of the whistleblowers for prompting the opening of the investigation and providing critical information, including information on “difficult to detect” violations. The whistleblower also identified key witnesses and helped staff “understand complex fact patterns and issues related to the matters under investigation.” The second whistleblower received a more than $3 million award for submitting important new information during the course of the investigation, which provided the staff a more complete picture. The SEC attributed the lower award amount to the fact that the second whistleblower delayed reporting the wrongdoing for several years, whereas the first whistleblower “persistently alerted the Commission to the ongoing abusive practices for a number of years before the investigation was opened.”
The SEC has awarded more than $1.3 billion to 281 individuals since issuing its first whistleblower award in 2012.