In This Issue

As the summer winds down and we move toward the fall, we find ourselves more virtually connected than ever because of COVID-19. The pandemic caused an initial slowdown in several parts of our industry: fundraising, due diligence, SEC examinations, hiring, and more. Many plans and goals from the beginning of the year were thwarted by the end of the first quarter.

But as the months have gone by, the world has adapted to this new normal and found ways to move forward.

We’ve leveraged technology to enabled scenarios that many firms previously considered impossible: an entirely remote workforce, fully remote due diligence exercises, and SEC interviews conducted from the comfort of the home.

Zoom is now a staple. We use video for meetings that were previously handled with a call. Hallway and watercooler conversations have found a new home in Slack and Teams.

As we embrace technology to achieve a new level of normal, we need to be cognizant about integrating best practices into how we communicate and operate. Almost every week, new security features are added to our favorite platforms, and we need to understand and adopt them. We also foresee new tools and technologies coming to the market that will continue to change and improve the way we work, communicate, and assess risk and reward.

If there is one positive takeaway from the COVID-19 pandemic, it’s the acceleration of some much-needed change. This change has led us not to isolation, but to a tightknit community where we occasionally mute Zoom to rock our babies or shush our canine friends.

JP Gonzalez

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Cayman Imposes New Registration Requirements for Private Equity, Other Closed-Ended Fund Structures

The Cayman Islands Government enacted the Private Funds Law, 2020 and an amendment to the Mutual Funds Law in early 2020 and set a compliance date of August 7, 2020. The legislation is the result of the European Union and others’ recommendations and has been developed to align the Cayman regulatory structure with other jurisdictions.

The Private Funds Law applies to any Cayman Islands closed-ended fund. If such a fund falls within the definition of a “private fund,” it will need to register with, and be regulated by, the Cayman Islands Monetary Authority (“CIMA”). Open-ended hedge funds and similarly structured pooled investment vehicles are not caught by this new law and will continue to be regulated by the Mutual Funds Law.

Private funds are companies, unit trusts or partnerships:

  • that are in the principal business of offering and issuing their interests for the purpose or elect of pooling investor funds to share investment risk and enable investors to participate in profits and gains from acquiring, holding, managing or disposing of investments,
  • where the investors do not control the day-to-day operation of the private fund (directly or indirectly), and
  • where the investments of the private fund are managed as a whole by the operator of the private fund for compensation based on the assets, profits, or gains of the entity constituting the private fund.


Private Equity Firm to Pay $1 Million to Settle Compliance Failures Related to MNPI Controls, No Insider Trading Alleged

On May 26, the SEC announced that private equity firm and registered investment adviser Ares Management LLC (“Ares”) had agreed to pay $1 million to settle charges of failing to implement and enforce policies and procedures to prevent misuse of material nonpublic information (“MNPI”). Worth noting, however, is that the SEC did not charge Ares with any substantive violation of insider trading laws and the matter “does not include any findings of misuse” of MNPI, as stated in an Ares press release published shortly after the order was made public.

The SEC’s order says that in 2016, Ares was able to appoint a senior employee to a public company’s board after investing several hundred million dollars via equity and debt investments. However, Ares’s compliance policies did not account for special circumstances presented by having an employee on a portfolio company’s board while that employee simultaneously participated in trading decisions regarding the portfolio company. Ares obtained potential material nonpublic information about the company relating to hedging strategy adjustments, senior management changes, and decisions about the company’s assets.

Ares bought 1 million shares, or about 17% of the public float, said information. However, the SEC’s order found that before approving the trades, Ares did not require its compliance staff to sufficiently inquire and document whether the board representative and members of his Ares team possessed material nonpublic information about the portfolio company.

Ares did not admit or deny the findings but consented to the entry of a cease-and-desist order, and to pay a $1 million civil penalty.

Greyline’s complete analysis of this case can be found here.

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Supreme Court Issues Opinion in Liu v. SEC

On June 22, 2020, the Supreme Court delivered a partial victory to the SEC by means of an 8-1 vote in Liu v. Securities and Exchange Commission.

Liu v. Securities and Exchange Commission stems from a nearly $27 million fraud effort by Charles Liu and his wife Xin Wang. The pair spent almost $20 million on “ostensible marketing expenses and salaries” and took the rest. A district court ordered disgorgement of the full amount paid to them and a civil penalty equal to their personal gains. Liu and Wang argued that the award did not account for their business expenses. The district court disagreed, and the Ninth Circuit affirmed.

The Supreme Court in its decision upheld the SEC’s ability to seek and obtain monetary disgorgement awards and affirms this as “equitable relief” in civil proceedings. However, the full opinion states that “The Court holds today that a disgorgement award that does not exceed a wrongdoer’s net profits and is awarded for victims is equitable relief permissible under §78u(d)(5).” As a result, when determining disgorgement amounts, legitimate business expenses are to be deducted from the profits to determine the overall net profit that can be returned to victims.

The new limitations could further complicate an already complex process, as the SEC will need to account for those net profits and legitimate expenses. It remains an open question whether the SEC can deposit fines into the U.S. Treasury, as it sometimes does when it cannot identify victims of misconduct. The Court declined to opine on this given that is was not a key component of the case and more information would be needed to render a decision on that. This is sure to set up future legal battles.

All this could threaten to reduce the overall money available to reward whistleblowers, which in turn could hamper anti-fraud efforts. It’s possible that the SEC might be impacted in its ability to seek disgorgements in situations where victim harm is difficult to determine (e.g., insider trading or FCPA violations). In those cases, the Treasury Department could potentially pursue criminal charges.

That said, the decision still is good news to the SEC given that disgorgements represented a majority (~71%) of its monetary remedies from 2015 to 2019, according to SEC data.

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Promoter Penalized Nearly $5 Million in Christian-Concert Fraud

On April 1, the Securities and Exchange Commission (“SEC”) obtained a final judgment against a Christian concert promoter who fraudulently raised more than $3 million in unregistered offerings through a promissory note program from about 145 investors.

Jefferey E. Wall, of Maine, and his business, The Lighthouse Events LLC (“Lighthouse”), were charged in April 2019 with community-based financial fraud related to Christian concerts and festivals. He promised investors their funds were “secured” and “guaranteed,” and that they would be used only to promote and host these Christian events. However, the funds were used for other purposes, including paying out earlier investors and paying off Lighthouse debt.

A U.S. magistrate judge ruled in favor of the SEC. It ordered Wall and Lighthouse to pay $1,589,815 in disgorgement of ill-gotten gains and $202,056 in prejudgment interest. Wall and Lighthouse also face $1,589,815 in civil penalties.

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Cantor Fitzgerald to Pay $3.2 Million in Blue Sheet Data Settlement

On April 6, the SEC announced that Cantor Fitzgerald & Co. (“Cantor”) agreed to pay $3.2 million for providing the SEC with incomplete and inaccurate “blue sheet data” over a nearly five-year period. Blue sheet requests from the SEC seek information from market makers, brokers and clearing houses about specific securities or transactions which may have impacted the price of the security.

Cantor provided “numerous” blue sheet submissions with missing or inaccurate data as the result of an inadequate accuracy-checking processes. The substandard submissions consisted of 14,868 blue sheets and covered some 35 million transactions.

The SEC found Cantor willfully violated the broker-dealer books and records and reporting provisions. Cantor admitted to the SEC’s findings and agreed to a $3.2 million penalty. Cantor was in the process of making remedial efforts to address the cause of its submissions.

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SEC’s OCIE Issues Risk Alerts About Reg BI, Form CRS Examinations

On April 7, the SEC’s Office of Compliance Inspections and Examinations (“OCIE”) issued two risk alerts:

These Risk Alerts were made ahead of the June 30, 2020 compliance date.

OCIE stated that examinations of broker-dealers will focus on whether broker-dealers are making good-faith efforts to implement policies and procedures reasonably designed to comply with Regulation Best Interest (“Reg BI”). This would include compliance with disclosure requirements, exercising due care, managing conflicts of interest, and other obligations that are specifically addressed in Reg BI. Additionally, Initial examinations will assess whether good-faith efforts have been made by broker-dealers and registered investment advisers to address Form CRS obligations. Specifically, OCIE will evaluate whether: (i) all of the Form’s requirements have been satisfied, (ii) disclosures are satisfactory, and (iii) all delivery obligations were met.

Peter Driscoll, Director of OCIE, calls both “critical to the protection of Main Street investors.”

The Financial Industry Regulatory Authority (“FINRA”) also issued a statement that echoed OCIE’s Risk Alerts and stated that it will also review broker-dealers for Reg BI compliance in its examinations.

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SEC Adopts Offering Reforms for BDCs, Registered CEFs

On April 8, the SEC voted to adopt rule amendments to implement certain provisions of the Small Business Credit Availability Act and the Economic Growth, Regulatory Relief, and Consumer Protection Act relating to business development companies (“BDCs”) and other closed-end funds (“CEFs”).

These rules will allow BDCs and other CEFs to use securities offering rules already available to operating companies. The hope is that streamlining the registration, offering and investor communications processes will benefit market participants and investors by modernizing disclosure and advancing capital formation.

Notable changes include the ability to: engage in a streamlined registration process to sell securities “off the shelf” more quickly and efficiently; qualify for “Well-Known Seasoned Issuer” status; and additional periodic reporting requirements. Each of these have requirements for size public float as well as other obligations.

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Two Traders Settle Fraud Charges in EDGAR Hacking Case

On April 9, the SEC announced it had settled with two traders – one foreign national, one American – that were part of a larger scheme to hack into the SEC’s Electronic Data Gathering, Analysis and Retrieval (“EDGAR”) system. EDGAR is the system used to collect data for public and non-public filings by investment managers, investment companies, and public companies.

David Kwon, of California, and Igor Sabodakha, of Ukraine, were among nine defendants that schemed to extract EDGAR data they could use for illegal trading. Specifically, a Ukrainian hacker allegedly extracted EDGAR files in connections with 157 earnings announcement that had yet to be announced. Kwon and Sabodakha, along with two others, then used this information to place trades. It total, they reaped over $4.1 million in gains. Sabodakha also allegedly previously traded on material non-public information obtained through hacks of at least two newswire services which was the first part of this overall scheme.

Kwon and Sabodakha consented to the entry of final judgments. Kwon agreed to pay $165,474 in disgorgement and $16,254 in prejudgment interest. Sabodakha agreed to disgorge $148,804 in profits, as well as pay prejudgment interest of $20,945 and a civil penalty of $148,804.

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SEC Charges Former Financial Services Executive With FCPA Violations

On April 13, the SEC charged Asante Berko, a former executive of a foreign-based subsidiary of a U.S. bank holding company, with orchestrating a bribery scheme in violation of the Foreign Corrupt Practices Act (“FCPA”).

Specifically, the SEC alleges that Berko arranged for his firm’s client, a Turkish energy company, to funnel at least $2.5 million to a Ghana-based intermediary. The goals was to bribe Ghanian government officials to facilitate approval of an electrical power plant project so that a client of the Turkish company would win a contract to build a power plant and sell power. In addition to the $2.5 million, the SEC also alleges Berko helped the intermediary pay more than $200,000 in bribes to other government officials, and that he personally paid more than $60,000 to government officials, including to members of the Ghanaian parliament. Communication also shows that when Berko reached an impasse with a government official, he would meet with the Minister of Power to discuss and resolve the issue. The SEC says Berko took deliberate measures to prevent his employer from learning about the scheme. The employing company was not included as a party to the action and was not referenced by name in the complaint – presumably, due to the company’s implementation of proper policies and procedures designed to deter such illicit activity.

The SEC’s complaint was filed in the U.S. District Court for the Eastern District of New York. The commission is charging Berko with violating the anti-bribery provisions of the FCPA and federal securities laws, and is seeking monetary penalties and other remedies.

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CFTC Unanimously Approves 3 Proposed Rules, 2 Final Rules at Open Meeting

On April 14, the Commodity Futures Trading Commission (“CFTC”) announced that it unanimously approved three proposed rules and two final rules.

The proposed rules:

  • Amendments to Part 190 Bankruptcy Regulations: The regulation pertains to futures commission merchants (“FCMs”). The proposal is the first substantive update to the rules in 37 years when they were enacted. This update in the regulation will meet current practices and other advances and seek to protect customers in an FCM’s bankruptcy proceedings.
  • Amendments to Compliance Requirements for Commodity Pool Operators on Form CPO-PQR: The proposal would amend both the Form CPO-PQR and Regulation 4.27 which reflects the CFTC’s effort to streamline data collection without hindering their ability to monitor. Information that is available to the CFTC by other means, for example, will not be requested in the CPO-PQR.
  • Amendments to Part 50 Clearing Requirements for Central Banks, Sovereigns, IFIs, Bank Holding Companies, and CDFIs: The proposal addresses the treatment of swaps by certain central banks, sovereign entities, and international financial institutions. Likewise, it includes amendments to exemptions from clearing swaps entered into by certain entities.

The final rules:

  • Amendments to Part 23 Margin Requirements for the European Stability Mechanism (“ESM”): The amendment codifies CFTC No Action Letter 19-22 concerning the ESM. The CFTC will not recommend enforcement against a registered swap dealer that does not follow the uncleared margin rules for swaps entered into the ESM.
  • Amendment to Part 160 Consumer Financial Information Privacy Regulation: The amendment was approved to restore language that was inadvertently deleted during a 2011 amendment.

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CFTC Charges Florida Man and his Companies in Fraudulent Forex and Digital Asset Scheme

On April 16, the CFTC charged a Florida man and two of his companies with fraudulently soliciting more than $1.6 million in connection with a leveraged or margined off-exchange foreign currency derivatives (“forex”) scheme.

The CFTC alleges that, starting as early as 2016 and through 2018, Alan Friedland and his companies – Fintech Investment Group, Inc. (“Fintech”) and Compcoin LLC – fraudulently solicited customers and prospective customers to purchase a digital asset called “Compcoin.” Customers were falsely promised that Compcoin would let them access a proprietary forex trading algorithm called “ART” that would deliver high rates of return. Friedland also held that ART had “eight years of controlled lab testing” and that Compcoin “delivered a 10% quarterly return on investment.”

The CFTC also alleges that the defendants falsely represented ART’s readiness for being released on the open market, as Fintech never obtained approval from the National Futures Association (“NFA”). As a result, Compcoin purchasers never gained access to ART, and their assets were worthless.

The CFTC is seeking civil monetary penalties, restitution, permanent registration and trading bans, and a permanent injunction against further violations of the Commodity Exchange Act and CFTC regulations. The NFA took related action on March 30 against Fintech and Friedland.

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SEC Orders 3 Self-Reporting Advisory Firms to Reimburse Investors

On April 17, the SEC announced settled charges against two advisers that self-reported as part of the Division of Enforcement’s Share Class Selection Disclosure Initiative (the “Share Class Initiative”), as well as a third that self-reported months after the initiative’s deadline.

The Share Class Initiative, announced February 12, 2018, allowed advisers to self-report failures to fully and fairly disclose conflicts of interests in selecting for a more expensive mutual fund share classes for advisory clients that paid 12b-1 fees when lower-cost share classes were available. In exchange for self-reporting, these advisers would be eligible for standard settlement terms that did not include civil penalties. The SEC, from March 11, 2019, through September 30, 2019, issued orders against 95 advisers through the initiative, and helped return nearly $140 million to harmed investors.

The SEC found that Merrill Lynch, Pierce, Fenner & Smith Incorporated and Eagle Strategies LLC violated Section 206(2) of the Investment Advisers Act of 1940, and ordered them to pay disgorgement and prejudgment interested totaling more than $425,000. They also must return money to investors.

The SEC also charged Cozad Asset Management, which reported after the deadline, with failing to fully disclose conflicts of interest. Cozad was found to have violated Sections 206(2) and 206(4) of the Advisers Act and Rule 206(4)-7 thereunder. Cozad was ordered to pay disgorgement and prejudgment interest totaling more than $400,000, as well as a $10,000 civil penalty, and to return the money to investors.

These actions represent the last of the Share Class Initiative self-reporting penalties.

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CFTC Designates Bitnomial Exchange, LLC as a Contract Market

On April 20, the CFTC announced it had issued an Order of Designation to Chicago-based Bitnomial Exchange, LLC, a bitcoin derivatives exchange, granting it immediate status as a designated contract market (“DCM”).

The CFTC says that, following a review, it determined that Bitnomial Exchange demonstrated its ability to comply with the requirements of the Commodity Exchange Act (“CEA”) and the CFTC’s regulations applicable to DCMs. Bitnomial first applied for the designation back in 2016. It now joins a handful of other DCMs in the ability to offer futures and options contracts on bitcoin.

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NFA Announces Rule 2-29 Amendments, Related Interpretive Notice Now Effective

On April 22, the NFA announced amendments, which were effective immediately. to Compliance Rule 2-29 and Interpretive Notice 9003 – NFA Compliance Rule 2-29: Communications with the Public and Promotional Material. The amendments allow commodity trading advisor (“CTA”) members that are also SEC registered investment advisers (“RIA”) to present past performance to eligible contract participants (“ECP”) on a gross basis in non-public, one-on-one presentations.

Qualifying members would be required to provide the ECP client with a written disclosure regarding the fact that the performance results do not reflect fees and expenses which reduce returns. Likewise, the firm must offer to provide performance results that are net of fees and expenses at or before exercising discretion over the client’s account.

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Canadian Man, Business Ordered to Pay More Than $1.7 Million to Settle CFTC Enforcement Action

On April 23, the CFTC announced that the U.S. District Court for the Southern District of New York entered a consent order of permanent injunction against a Canadian man and his business to resolve a CFTC enforcement action charging the defendants with fraud and making false statements to the NFA.

The CFTC says between at least July 1, 2014, and around January 31, 2016, Simon Jousef, of Ontario, Canada, and his business, FuturesFX, fraudulently solicited members and prospective members in the U.S. and around the world to subscribe to a trading system. Jousef led members to believe the system gave them access to a “live” forex and commodity futures online trading room, educational videos, and online support. In the trading room, members could see him “trading” his program when, in fact, all of the trades were hypothetical or simulated. The order says the defendants made “numerous materially false and misleading statements and omissions on the company’s websites, in the online trade room, and in email advertisements” to entice prospective members into buying memberships. For example, Jousef claimed that, had a member followed his trades in 2014, they would have seen a 640% return.

The scheme brought in roughly $1.3 million in subscription fees from more than 300 members. The order imposes more than $1.7 million in civil monetary and equitable relief.

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SEC Directs Equity Exchanges, FINRA to Improve Governance of Market Data Plans

On May 6, the SEC issued an order directing equity exchanges and FINRA to submit a new National Market System plan (“NMS plan”) with a modernized governance structure for producing public consolidated equity market data and disseminating trade and quote data from trading venues.

Currently, three national market system plans approved by the SEC facilitate the collection, consolidation, and dissemination of information regarding NMS stocks.

The SEC says that “recent market developments have given rise to concerns about whether, as currently structured, the existing NMS plans for equity market data continue to fulfill their regulatory purpose.” It says the new order addresses inherent conflicts of interest and should improve the efficiency of NMS plan operations, as well as responsiveness of the plan to the concerns of non-SRO (self-regulatory organization) market participants.

The New Consolidated Data Plan must be submitted within 90 days of the order. The SEC had already approved previous amendments as well which required participants to make mandatory their current disclosure policies regarding conflicts of interest and establish a policy regarding the confidential treatment of any data or information.

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ransomware risk alert

CFTC Orders Trader, Firm to Pay $150,000 for Wash Sales

On May 7, the CFTC filed and settled charges against Mehran Khorrami and his firm, Cayley Investment Management (“CIM”) for engaging in wash sales and non-competitive transactions.

As defined by CFTC case law, a trade results in a wash sale “when the purchase and sale of the same delivery month of the same futures contract at the same or similar price.” To show a violation of CTFC rule, the trader must also demonstrate an intent to negate risk or price competition and avoid a bona fide market position, which can be inferred from prearrangement or similar such structuring of the transactions.

The CFTC says Mehran Khorrami and CIM engaged in wash sales and non-competitive transactions in forex, crude oil and gold futures for accounts held by a CIM client. Specifically, on February 8, 2018, Khorrami placed simultaneous buy and sell orders in six different CME futures contracts. The orders were at different bid and offer prices initially, but when the orders went unfilled, Khorrami repeatedly modified those order until the bid and offer prices matched. This resulted in a series of prearranged cross trades in Crude Oil, the British Pound, Euro FX, the Swiss Franc, and Gold, all traded in odd lots.

Khorrami and CIM were ordered to pay a $150,000 civil monetary penalty. The Chicago Mercantile Exchange (“CME”) made a parallel inquiry and issued a Notice of Disciplinary Action. Khorrami agreed to a $30,000 fine and a 10-day suspension.

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CFTC Files Charges in $20 Million Binary Options, Digital Asset Fraud Scheme

On May 7, the CFTC announced it had filed charges against three individuals and three companies for their alleged roles in a scheme that generated more than $20 million in commission payments.

The defendants include Florida-based Daniel Fingerhut, three companies that he worked with – Florida corporation Digital Platinum, Inc., Israeli company Digital Platinum, Ltd. and Bulgarian company Huf Mediya Ltd. – and Israelis Tal Valariola and Itay Barak, control persons of all three entities.

The CFTC alleges, starting at least in October 2013 and going through August 2018, the defendants created fraudulent marketing materials promising no risk and astronomical profits to encourage customers to open and fund off-exchange binary options and digital asset trading accounts. Millions of fraudulent solicitations were sent and more than 59,000 customers opened and funded such accounts, generating more than $20 million in commission payments to the defendants. The marketing materials included fake trading performance, as well as actors falsely claiming they had become rich via trading, while standing in front of props such as mansions and jets. Although Fingerhut had no legitimate source of income, he was able to pay off his mortgage from the fraudulent funds he received.

Upon receipt of the subpoena for investigations into the marketing fraud, Fingerhut agreed to cooperate with the CFTC and provide a sworn testimony. While under oath, he made an effort to conceal the extent of his involvement in the fraud and avoided document production. As a result, he was also charged with making materially false or misleading statements to CFTC staff, including while under oath.

The CFTC is seeking full restitution to defrauded individuals, disgorgement of ill-gotten gains, civil monetary penalties, permanent registration and trading bans, and permanent injunctions against further violations.

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Morgan Stanley Smith Barney Charged With Providing Misleading Information to Retail Clients

On May 12, the SEC announced that Morgan Stanley Smith Barney LLC (“Morgan Stanley”) agreed to pay a $5 million penalty, to be distributed to harmed investors, as part of a settlement of charges over providing misleading information to retail clients.

The SEC found that Morgan Stanley marketed wrap free accounts – in which clients pay an asset-based “wrap fee” that covers investment advice and brokerage services – as offering a number of services within a “transparent” fee structure. From at least October 2012 to June 2017, some Morgan Stanley marketing and client communications gave the impression that these clients were not likely to incur additional trade execution costs. During that period however, some Morgan Stanley managers routinely directed these clients’ trades to third-party broker-dealers, which sometimes resulted in additional transaction fees not visible to the wrap fee account clients. Client agreements also stated that Morgan Stanley would execute “most” trades and its Form ADV states that this “usually” occurs. Morgan Stanley knew that several wrap fee managers rarely if ever executed trades through its trading desks, which is particularly common for certain fixed income managers engaging in “trade aways” or “step-out transactions.” Therefore, Morgan Stanley knowingly, or at the very least negligently, misled clients.

Morgan Stanley did not admit or deny the findings but consented to the SEC’s order that finds Morgan Stanley violated provisions of the Advisers Act.

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SEC Obtains Receiver Over Florida Investment Adviser Charged With Fraud

On May 12, the SEC announced it obtained the appointment of a receiver over Florida-based investment adviser TCA Fund Management Group Corp. (“TCA”), affiliate TCA Global Credit Fund GP Ltd. (“TCA-GP”), and several funds managed by TCA to protect investors from a fraudulent scheme TCA allegedly conducted.

TCA provided financing and investment banking services to portfolio companies, including the issuance of loans which was the revenue source that TCA exploited. Essentially, upon the execution of a loan or facility, TCA would recognize the entirety of the revenue before it had been realized. The SEC alleges that TCA improperly recognized this revenue to fraudulently inflate net asset values (“NAV”) and performance for several of its funds, allowing it to always report positive returns. The SEC asserts that TCA distributed promotional materials to current and prospective investors whom relied on the false statements as a basis for investing. For instance, the funds reported NAV of $516 million as of November 2019, but the SEC says this figure was inflated by at least $130 million. TCA and TCA-GP also allegedly falsely represented monthly returns and investment balances in monthly capital account statements to investors.

TCA and TCA-GP have been charged with violating the antifraud provisions of the federal securities laws. The SEC seeks permanent injunctions, disgorgement of allegedly ill-gotten gains with prejudgment interest, and financial penalties.

The U.S. District Court for the Southern District of Florida granted the SEC’s request to appoint Jonathan E. Perlman as receiver over TCA, TCA-GP and the TCA funds.

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Credit Rating Agency to Pay $3.5 Million for Conflicts of Interest Violations

On May 15, the SEC charged New York-based credit rating agency Morningstar Credit Ratings LLC (“Morningstar”) for violating a conflict of interest rule whereby employees who determined or monitored credit ratings were also involved in the sales and/or marketing of products and other services.

The SEC found that from mid-2015 through September 2016, credit rating analysts in Morningstar’s asset-backed securities (“ABS”) group engaged in sales and marketing to prospective clients. Morningstar’s head of business development instructed analysts to identify business targets and pursue them through marketing calls, meetings, and offers to provide indicative ratings. In one instance, an ABS analyst wrote a commentary specifically aimed at an issuer so that it would become a client.

The order found that Morningstar issued and maintained ABS ratings for certain entities where an analyst who participated in determining or monitoring the credit rating also sold or marketed a Morningstar product or service. The order also found that between at least June 2015 and November 2016, Morningstar failed to maintain written policies and procedures reasonably designed to separate its analytical and business development arms.

The SEC order found that Morningstar violated Rule 17g-5(c)(8)(i), which is designed to separate credit ratings and analysis from sales and marketing efforts.

Morningstar agreed to pay $3.5 million to settle the charges.

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SEC Shuts Down Fraudulent Investment Adviser Targeting Senior Citizens

On May 22, the SEC announced it had filed an emergency action against a California-registered investment adviser and his entities that were allegedly running a Ponzi scheme targeting senior citizens in Southern California.

The SEC says that starting at least in January 2018, Paul Horton Smith Sr., a self-proclaimed “veteran of the financial services industry,” offered and sold securities in his company Northstar Communications LLC (“Northstar”). He also used his investment advisory firm eGate LLC, as well as his insurance and estate planning company Planning Services Inc., to market Northstar securities. Smith and Northstar allegedly promised 3% and 10.5% in guaranteed annual interest payments for investing in “private annuity contracts.” Although Smith claimed in a workshop that investors’ “pockets aren’t going to get picked…we’re all fiduciaries,” investors pockets were in fact picked. The SEC alleges that investor funds were not used to invest in securities, but instead used to pay returns in a Ponzi-like fashion.

The complaint says Northstar raised more than $5.6 million from at least 35 investors, and paid out $5.3 million to investors, claiming they were interest payments or principal returned.

The SEC charges Smith, Northstar, eGate, and Planning Services with violating the antifraud provisions of the federal securities laws. The SEC also obtained a temporary restraining order and an asset freeze against Smith and his entities.

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Film Distribution Company Owner Charged With Defrauding Publicly Traded Fund

On May 22, the SEC announced charges against William Sadleir, the owner of film distribution firm Aviron Group LLC (“Aviron”), for allegedly committing fraud against a publicly traded fund.

The SEC alleges that BlackRock Multi-Sector Income Trust (“BIT”), a registered closed-end management investment company, invested about $75 million in Aviron. While Sadleir said those investments would be used to support film distribution, he allegedly used a sham company to fraudulently divert and misappropriate BIT funds, and even issued fake invoices seeking BIT funds for services never provided. Sadlier even forged BIT personnel’s signatures to authorize the release of collateral which was valued at $3 million. The funds were instead used for personal expenses, which included buying, furnishing, and renovating a Beverly Hills mansion, the SEC alleges.

The SEC’s complaint charges Sadleir with violating the antifraud provisions of the federal securities laws and seeks disgorgement of ill-gotten gains, civil penalties, and permanent injunctive relief.

The U.S. Attorney’s Office for the Southern District of New York filed criminal charges against Sadleir on May 22 in a parallel action.

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Unregistered ICO Issuer Ordered to Return Millions to Investors

On May 28, the SEC announced charges against California-based blockchain services company BitClave PTE Ltd. (“BitClave”) for conducting an unregistered initial coin offering (“ICO”) of digital asset securities.

The SEC says BitClave raised more than $25 million from roughly 9,500 investors between June and November 2017 via the sale of Consumer Activity Tokens (“CAT”). BitClave planned to use the proceeds to develop, administer, and market a blockchain-based search platform for targeted consumer advertising. It also emphasized its expectation that the tokens would grow in value, and tried to make the tokens available for trading on third-party digital asset trading platforms. However, BitClave did not register its offers and sales of CAT, which has since been removed from many of the trading platforms.

BitClave, which is winding down its operations, has agreed to pay disgorgement of $25.5 million, prejudgment interest of $3,444,197, and a penalty of $400,000. BitClave will return money to injured investors via a Fair Fund, and transfer all remaining CAT in its control to the fund administrator for permanent disabling.

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FINRA Sanctions Stifel More Than $3.6 Million for Violations Involving Unit Investment Trusts

On May 28, FINRA announced it had ordered Stifel, Nicolaus & Company, Incorporated (“Stifel”), to pay more than $3.6 million for violations connected to early rollovers of Unit Investment Trusts (“UIT”).

UITs are a one-time offering of securities based on a fixed portfolio that has a set lifetime, typically of 12 or 15 months. At the end of the UIT’s life, the securities are sold and money is returned. Sponsors will typically offer series which coincide with the maturity date of the previous series allowing unit holders to roll one series into the next. Typically, sponsors will charge an upfront sales fee, a deferred sales fee, and a creation and development fee. When unit holders roll over however, the upfront sales fee is typically waived. If a manager continually recommends roll overs before the UITs maturity date and does not waive the upfront fee, the sponsor will yield higher revenue at the expense of unit holder which is what happened in the Stifel case.

FINRA says that Stifel executed $10.9 billion in UIT transactions, about 86% of which was involved in early rollovers, between January 2012 and December 2016. FINRA found Stifel did not have reasonably designed supervisory systems and procedures in place to determine the suitability of those rollovers, and thus did not identify that its representatives recommended early rollovers that might have caused customers to incur approximately $1.9 million in excess fees. A system was in place where an alert was sent to branch managers if a UIT was rolled over as well as alert for switches between UITs and mutual funds. However, in 2012 the compliance department discovered that the system was only flagging switches between mutual funds and mutual fund to UITs but not UIT rollovers. Rather than escalating the issue, compliance did nothing. FINRA also says Stifel sent approximately 600 letters to customers containing inaccurate information or missing information about UIT rollover costs, underestimating those costs by nearly half.

Stifel neither admitted nor denied the charges, but agreed to pay $1.9 million in restitution, plus interest, to more than 1,700 customers involved, as well as a $1.75 million fine.

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NFA Permanently Bars Hong Kong Commodity Pool Operator, Principal From Membership

On June 1, the NFA announced it had permanently barred Bainbridge Asia Limited (“Bainbridge”), a Hong Kong-based NFA Member commodity pool operator, as well as sole principal Wai Man Yip, from membership and from acting as principal of an NFA Member.

In a complaint, the NFA said that starting in late January 2020, it investigated apparent inconsistencies between information provided to the NFA and information posted on its website. For instance, Bainbridge’s registration and membership filings with the NFA listed a Hong Kong address, but the firm’s website included addresses in Queens, New York, which were not listed in filings to the NFA. This and other inconsistencies caused the NFA to contact Yip in November 2019 to reconcile those inconsistencies, but the NFA said Yip continued to provide conflicting information to the NFA. The NFA later required Bainbridge to deactivate its website, which was confirmed deactivated on December 16, 2019.

The NFA then conducted a surprise visit in early January 2020 to the Queens address, but examiners found the address was just a P.O. Box, and that no one from the firm was present at the location. Prior to the surprise visit, NFA discovered another Bainbridge website that was “virtually identical” to the deactivated website.

In the months that followed, Yip failed to meet a deadline for a document request, and failed to respond to follow-up emails and calls.

Due to this, the NFA’s Business Conduct Committee found that Bainbridge and Yip are therefore “deemed to have admitted the facts and legal conclusions alleged in the Complaint and to have waived their right to a hearing.” Thus, they were found to have failed to cooperate with NFA during an examination, violating NFA Compliance Rule 2-5.

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Kentucky Man Charged in Multimillion-Dollar Fraud Scheme

On June 2, the CFTC announced it had charged William S. Evans III (d/b/a/ Turning Point Investments) with fraud in a commodity trading scheme.

The CFTC alleges that since at least September 2018, Evans accepted at least $10 million from clients that he solicited to trade S&P commodity futures contracts and options in a commodity pool. The CFTC says Evans misappropriated at least $8.4 million, using some to pay clients in a Ponzi-like manner while using some for personal use. While Evans promised double-digit profits, he engaged in transactions that racked up losses he failed to disclose.

The CFTC also alleges Evans acted in a capacity that required him to register with the CFTC as a commodity pool operator, but that he failed to do so.

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Merrill Lynch, Pierce, Fenner & Smith Inc. to Pay $7.2 Million in Restitution to Customers

On June 4, FINRA announced it had ordered Merrill Lynch, Pierce, Fenner & Smith Inc. (“Merrill Lynch”) to pay more than $7.2 million in restitution and interest to customers who absorbed unnecessary sales charges and excess fees in mutual fund transactions. These finding were brought to light during a routine examination by FINRA, illustrating an ever-growing cooperation amongst industry regulators.

Mutual fund issuers typically allow investors to buy fund shares, after previously selling shares of that fund or another fund in the same family, without incurring a front-end sales charge, or to recoup all or part of a contingent deferred sales charge.

However, FINRA found that between April 2011 and April 2017, Merrill Lynch did not have reasonably designed supervisory systems and procedures in place to ensure mutual fund investors received those waivers or rebates through such “rights of reinstatement.” Instead, registered representatives manually identified and applied waivers and rebates – an “unreasonably designed system” given the complexity of the task and the high number of accounts involved (more than 13,000).

FINRA also found that Merrill Lynch failed to reasonably monitor for missed reinstatements. There was a software in place, but this only monitored accounts that sold a mutual fund in the same family within the past week. This was inadequate because most of the mutual funds on Merrill Lynch’s platform waived sales charges or issued rebates when investors reinvested between 30 and 120 days.

This all resulted in sales charge waivers and fee rebates totaling more than $7.2 million, including interest, that were not provided to eligible accounts.

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CFTC Orders U.K. Company to Pay More Than $490,000 for Registration, Supervision Violations

On June 8, the CFTC issued an order filing and settling charges against London, England-based Gain Capital UK Limited (“Gain UK”) for failing to register as a retail foreign exchange dealer (“RFED”) and for supervision violations related to the handling of a customer account managed by an unregistered CTA.

Between at least February 6, 2014, and March 8, 2019, Gain UK acted as a counterparty to U.S.-based forex customers without registering as an RFED as required by the CEA and CFTC regulations, the order says. Gain UK accepted customers that provided U.S.-based mailing addresses on applications, and that provided documents (such as lease agreements) that showed they were located in the U.S. One customer even disclosed to a Gain UK employee that she was a student at a U.S. university.

The order also finds that Gain UK failed to diligently supervise the handling of a U.S.-based retail forex customer account. Specifically, it failed to detect warning signs of the underlying fraudulent conduct by an unregistered CTA who solicited the retail forex customer to open an account. In one instance, an unregistered CTA’s fraudulent conduct led a customer to suffer $280,000 in losses while Gain UK earned $241,671.

The CFTC ordered Gain UK to pay a $250,000 civil monetary penalty and to disgorge $241,671.

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NFA Comments on CFTC’s Proposed Amendments to Commission Regulation 4.27 Regarding CFTC Form CPO-PQR

On June 10, the NFA submitted comments to the CFTC concerning its proposed amendments to Commission Regulation 4.27 regarding CFTC Form CPO-PQR. The NFA voiced its support for efforts to streamline and simplify commodity pool operator (“CPO”) reporting requirements, but presented comments concerning the Schedule of Investments and Alternative Filing of SEC Form PF.

The CFTC requested comment about the content of the Schedule of Investments, including whether it should be amended to align it with the schedule that appeared in NFA’s Form PQR in 2010. NFA voiced its full support of said amendment, saying it would “significantly alleviate filing burdens on CPOs without negatively impacting the usefulness of the information that is collected.”

The CFTC also requested comment on whether CPOs should be required to file all or part of SEC Form PF with NFA in lieu of filing CFTC Form CPO-PQR. The NFA says it does not support this alternative citing that the Form PF requires significantly more information than the CPO-PQR and the information needed for the PF is “at least as burdensome” as the CPO-PQR. Therefore, it would not be a benefit to the NFA or CPOs to institute this change.

The NFA also requested that the CFTC review reporting instructions for any changes necessary based on final rule amendments.

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CFTC Charges Unregistered Commodity Pool Operator, CEO With Solicitation Fraud and Misappropriation

On June 11, the CFTC charged New York-based Craig L. Clavin and his company Lighthouse Futures, Ltd. (“Lighthouse”), with fraudulently soliciting commodity pool participants, misappropriating pool funds, commingling pool funds with other funds, and failing to register with the commission as a CPO.

The CFTC alleges that, between at least 2015 and 2019, Clavin and Lighthouse fraudulently solicited and misappropriated at least $345,000 from U.S. residents from pooled investments in commodity futures contracts. Once invested, participants were required to stay invested for a year with a guarantee that their principal would not be lost. After the year, they could choose to reinvest or withdraw with all “profits” being split between Clavin and the participants. They allegedly concealed their fraud with false performance reports and account statements.

The vast majority of pool participants’ funds were never traded, but instead used to pay Clavin’s personal expenses, including travel, meals, patio furniture, and debit card purchases. Some funds were also used to pay pool participants in a Ponzi-like manner.

The CFTC also alleges Lighthouse illegally operated as an unregistered CPO and that Clavin acted as an unregistered associated person of Lighthouse.

The CFTC is seeking disgorgement of ill-gotten gains, civil monetary penalties, restitution, permanent registration and trading bans, and a permanent injunction against further violations.

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Trading Advisor Ordered to Pay $890,000 for Defrauding Church, Community Members in Forex Scheme

On June 11, the CFTC announced that the U.S. District Court for the Southern District of New York entered a consent order for permanent injunction and other equitable relief against a Florida man who was found to have fraudulently solicited at least 13 individuals to trade off-exchange forex transactions and misappropriated funds of at least two clients.

The order finds that Florida-based Brett G. Hartshorn engaged in the forex scheme between June 18, 2008 to around 2014, falsely telling most (if not all) of his clients that he had profitably traded forex for himself and others, that clients could expect substantial profits if they let him trade forex for them. He even told one person that he can double their money in a matter of months. However, Hartshorn repeatedly engaged in risky trading strategies and suffered significant losses for his clients. On certain days, Hartshorn experienced large single day losses and devastating margin calls but never disclosed this to clients.

The order also found that Hartshorn failed to disclose that he could be (and often was) compensated even as his clients lost money. In addition, he failed to register as a CTA as required under the CEA and CFTC regulations. Hartshorn admitted to these and other findings.

Hartshorn also pleaded guilty to willfully making false statements to the FBI relating to his misappropriation of client funds, in a parallel criminal action pending in the U.S. District Court for the Middle District of Florida.

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SEC Charges Broker With Defrauding Seniors Out of Nearly $1 Million

On June 12, the SEC charged a Nashville-based securities broker for defrauding two seniors out of nearly $1 million.

The SEC alleges Frederick Stow acted as a World War II-era veteran’s registered representative for more than three decades and inserted himself into the veteran’s personal and financial affairs. According to the complaint, Stow started to make unauthorized securities sales from the veteran’s individual retirement account beginning in October 2015. On 74 occasions, Stow allegedly transferred sales proceeds to his own bank account. Moreover, a month after the veteran’s death in March 2019, Stow allegedly stole money from another senior by wiring money from the senior’s brokerage account to his own bank account, without proper authorization. Eventually, the executor for the estate of the first customer began to ask Stow about the transfers and demanded explanations. Stow then confessed to stealing the clients’ money and was terminated thereafter. He now works part-time at retail stores in the area.

The SEC alleges Stow stole $933,500 in total. The commission is seeking injunctive relief, the return of allegedly ill-gotten gains plus prejudgment interest, and a civil penalty. The U.S. Attorney’s Office for the Middle District of Tennessee filed criminal charges against Stow in a parallel action.

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NFA Announces Amendments to NFA Interpretive Notice 9045 Now Effective

On June 16, the NFA announced that amendments to Interpretive Notice 9045 – FCM and IB Anti-Money Laundering Program were effective immediately.

NFA Compliance Rule 2-9(c) and Interpretive Notice 9045 requires that all FCMs and introducing brokers (“IB”) implements an anti-money laundering (“AML”) program that satisfied the requirements and regulations of the Bank Secrecy Act. This then included obligations related to the Customer Identification Program (“CIP”) and Beneficial Ownership (“BO”)

The amendments on June 16th  clarify that voice broker IBs are not required to establish and implement a CIP or apply BO requirements with respect to their voice broker business. That said, voice broker IBs must continue to conduct suspicious activity reviews and comply with other applicable NFA requirements.

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Deutsche Bank to Pay More Than $10 Million to Settle Two CFTC Cases

On June 18, the CFTC announced it had settled two enforcement matters against Deutsche Bank that will require two of its entities to pay a combined $10.25 million.

In the first case, Deutsche Bank AG (“Deutsche Bank”) was charged in connection with violating swap data reporting requirements, failing to supervise its business continuity and disaster plan, and violating a 2015 CFTC order. Starting April 16, 2016, Deutsche Bank suffered an “unprecedented” swap reporting platform outage in which the bank could not report any swap data for multiple asset classes for several days. The consent order says Deutsche Bank’s efforts to end the outage exacerbated existing reporting problems and led to new reporting problems, many of which violated the 2015 order. Deutsche Bank is required to pay a $9 million civil monetary penalty to settle that case. In addition, given the multitude of failures, an independent monitor has been appointed to facilitate Deutsche Bank’s swap data reporting compliance.

In the second case, Deutsche Bank Securities Inc. (“DBSI”) was charged with engaging in numerous instances of spoofing in Treasury futures and Eurodollar futures contracts on the CME. DBSI, by and through the acts of two Tokyo-based traders, engaged in spoofing between at least January 2013 through at least December 2013. Deutsche Bank’s cooperation in the investigation led to a reduced civil monetary penalty of $1,250,000.

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Form CRS

SEC Halts Brothers’ Cryptocurrency Fraud

On June 19, the SEC announced it filed an emergency action and obtained a temporary restraining order and asset freeze against two Pennsylvania-based brothers to stop a digital asset offering scheme.

The SEC says that from at least July 2019 through May 2020, Sean and Shane Hvizdzak offered securities in a private fund purporting to invest in digital assets. However, the brothers allegedly misrepresented fund performance, fabricated financial statements and forged audit documents. Marketing materials claimed the fund earned 100.77% during the third quarter of 2019, and 92.90% in Q4 2019, when in fact the fund lost money in both quarters. The SEC also alleges the brothers diverted tens of millions of dollars from the fund to personal bank accounts and digital asset trading platform accounts, then transferred the assets on multiple blockchains to themselves and others.

The complaint charges the Hvizdaks, as well as Hvizdak Capital Management, LLC, High Street Capital, LLC, and High Street Capital Partners, LLC, with violating the antifraud provisions of federal securities laws.

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SEC, DOJ Antitrust Division Sign Historic Memorandum of Understanding

On June 22, the SEC and the Department of Justice’s (“DOJ”) Antitrust Division announced they had signed an interagency Memorandum of Understanding (“MOU”) to foster cooperation and communication between those agencies.

A key provision of the MOU establishes a framework for the SEC and DOJ’s Antitrust Division to continue regular discussions. This would include reviews of law enforcement and regulatory matters affecting securities industry competition and provisions to establish periodic meetings among both agencies’ officials.

The MOU also provides for the exchange of information and expertise believed to be potentially relevant and useful to oversight and enforcement efforts.

“As competition is embedded in our securities laws, there are many policy areas where the missions of the SEC and DOJ’s Antritrust Division align, but where our respective areas of expertise differ,” SEC Chairman Jay Clayton says. “By formalizing the exchange of knowledge between our agencies, we aim to foster even greater collaboration and cooperation to ensure that we maintain the efficient and competitive markets that American investors rely on.”

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