The SEC Division of Examinations recently released its 2022 Division of Examinations “Priorities.” The 2022 Priorities provide critical insight into what the Division of Examinations (the “Division”) considers the most significant and highest potential risk areas for investors, and provides guidance for regulated entities on where to focus their compliance efforts.
The lack of specific guidance regarding failure to supervise liability for chief compliance officers (“CCOs”) has been a controversial and opaque topic that both FINRA and the SEC have struggled with for well over a decade. Back on September 30, 2013, the SEC’s Division of Trading and Markets issued guidance with “FAQs” entitled “Frequently Asked Questions about Liability of Compliance and Legal Personnel at Broker-Dealers under Sections 15(b)(4) and 15(b)(6) of the Exchange Act.” These FAQs focused on the potential supervisory liability of compliance personnel. Just over two years later, on November 4, 2015, the then Director of the Division of Enforcement gave the keynote address at the 2015 National Society of Compliance Professionals, National Conference, in which he described a limited number of categories regarding the infrequent circumstances in which the SEC would consider charging a CCO. Despite these and other historical attempts at clarifying guidance, just this past year we have seen additional attempts to seek and obtain more regulatory clarity for this high-risk area. On June 2, 2021, the New York City Bar issued a Committee Report entitled “Framework for Chief Compliance Officer Liability in the Financial Sector.” Most recently and earlier this year, the National Society of Compliance Professionals (“NSCP”) offered a “Firm and CCO Liability Framework.” (More information on this can be found on NSCP’s website.) In this “Framework,” NSCP proposed that regulators consider CCO liability contextually in reference to resources made available to CCOs in the first instance.
In recent years, the SEC has been conducting a nationwide and industry-wide “sweep” of investment advisory firms, pursuant to which it has opened investigations and brought enforcement actions against a multitude of investment advisory firms related to their disclosures and practices concerning revenue sharing and other alleged financial conflicts.1 We have previously blogged about litigated disclosure cases2 and given the fact that litigated decisions are the true test of enforcement theories, compared to settlements that may pose untested legal theories regarding potential violations, contested proceedings should be followed closely.
In one of the most recent of these actions, on March 1, 2022, the SEC filed an action against Cambridge Investment Research Advisors, Inc. (“CIRA”), a registered investment adviser.3 The SEC alleges CIRA failed to adequately disclose conflicts of interest and failed to seek best execution in connection with its receipt of revenue sharing from client investments in no-transaction fee mutual funds (“NTF mutual funds”) and money market sweep funds (“sweep funds”), its conversion of client accounts to wrap account programs, and its investment adviser representatives’ receipt of compensation of forgivable loans in exchange for meeting certain investment criteria. These undisclosed investment practices, the complaint alleges, also allowed CIRA to avoid paying millions of dollars in transaction fees. In addition, according to the complaint, CIRA converted hundreds of accounts to its more expensive wrap account program without adequate disclosure and without analyzing whether doing so was in its clients’ best interests. The complaint further alleges that CIRA failed to disclose that its investment adviser representatives received compensation in the form of forgivable loans in exchange for meeting certain criteria such as maintaining certain asset levels and tenure with CIRA.
Continue reading “The SEC Sues Investment Advisory Firm in Connection with Alleged Failure to Disclose Revenue Sharing and Other Financial Conflicts, as Well as Converting Clients to Wrap Accounts Without Considering Whether it is in Clients’ Best Interests”
On February 24, 2022, two of three founders of an off-shore cryptocurrency derivatives exchange, the Bitcoin Mercantile Exchange or “BitMEX,” pled guilty to violating the Bank Secrecy Act (BSA) by failing to maintain an anti-money laundering program. Pursuant to their respective plea agreements, defendants Arthur Hayes and Benjamin Delo each agreed to pay a $10 million criminal fine and face up to five years in prison. The defendants’ guilty pleas were entered approximately one month before they were scheduled to stand trial in the United States District Court for the Southern District of New York.
Hayes and Delo – along with two other BitMEX executives – were indicted in October 2020 for evading U.S. anti-money laundering rules. A Department of Justice (DOJ) press release announcing the charges detailed that BitMEX was required to register with the Commodity Futures Trading Commission (CFTC) and to establish an adequate anti-money laundering program because it solicited and serviced U.S. traders. Despite these obligations, BitMEX had only nominal programs in place to combat money laundering which, according to DOJ, were “toothless or easily overridden to serve BitMEX’s bottom line goal of obtaining revenue through the U.S. market without regard to U.S. regulation.”
On February 14, 2022, the SEC announced charges against BlockFi Lending LLC – a New Jersey-based cryptocurrency lending platform – for failing to register its crypto lending product and violating the Investment Company Act of 1940. BlockFi agreed to a settlement in which it will pay a $50 million penalty, cease unregistered offers and sales of its lending product, and attempt to bring its business in compliance with the Investment Company Act within sixty (60) days. Additionally, BlockFi agreed to pay $50 million in fines to 32 states to settle similar charges.
BlockFi offered and sold to investors BlockFi Interest Accounts (“BIAs”), through which investors lent crypto assets to BlockFi and, in exchange, BlockFi promised variable monthly interest payments paid in cryptocurrency. The SEC’s Order sets forth the Commission’s findings. First, it concluded that the BIAs were securities because they were notes under Reeves v. Ernst & Young, 494 U.S. 56 (1990), and because they were sold as investment contracts under SEC v. W.J. Howey Co., 328 U.S. 293 (1946). Second, the SEC found that BlockFi was engaged in an illegally unregistered securities offering. Third, it found that BlockFi violated Sections 17(a)(2) and 17(a)(3) of the Securities Act by making materially false and misleading statements concerning its collateral practices and the risks associated with its lending activity. Finally, the SEC determined that BlockFi was operating as an unregistered investment company.
On Wednesday, the Securities and Exchange Commission announced proposed new cybersecurity risk management rules and amendments for investment advisers and investment companies. The proposed rules are designed to address concerns about advisers’ and funds’ cybersecurity preparedness and incident response in an effort to strengthen client and investor protection. The proposed rules include the following:
The SEC’s disgorgement request in a litigated proceeding in federal district court is being challenged in the wake of the Supreme Court’s 2020 decision in Liu v. SEC, which limited how much the agency can seek in disgorgement.
In April 2015, the SEC filed a complaint in the U.S. District Court for the Northern District of Texas against two California oil-and-gas companies, Team Resources, Inc., and Fossil Energy Corporation, their common principal, and four sales associates (collectively, “Team Resources”) for allegedly operating a fraudulent oil and gas production scheme. The SEC charged that Team Resources lured investors to the oil companies by touting unreasonable oil and gas production figures and distributing misleading information regarding the companies’ operations.
The SEC has, for many years, used broker-dealer and associated persons’ failure to create and maintain books and records as a basis for the imposition of serious penalties. In recent actions, it appears to be continuing—and upping the ante on—its enforcement in this area.
Simply stated, it is increasingly imperative for broker-dealers and investment advisory businesses, among other entities, to develop and maintain policies and procedures to ensure that their records are properly created, maintained, and produced to the appropriate agency upon request—including that employees’ communications related to their business should be made only through approved channels, and approved and monitored devices, such that those communications can be maintained and preserved for production as required by federal securities laws and regulatory authorities, and in any pending or threatened litigation.