Daniel Nathan

Partner

Washington, D.C.


Read full biography at www.orrick.com

Daniel Nathan uses his deep enforcement and regulatory experience to represent U.S. and international financial institutions and individuals before financial regulators.

With a combined 25 years as a senior enforcement official with the SEC, CFTC and FINRA, three of the country’s leading regulatory and enforcement authorities, Dan is a particularly effective advocate for those facing investigations and/or enforcement action by those regulators.

Daniel’s intimate knowledge of broker-dealer regulation provides clients facing SEC or FINRA examinations and enforcement investigations with experienced counsel related to broker-dealer supervisory procedures, sales practices, anti-money laundering, ETF regulation, product disclosure and supervision, and securities and broker registration. His extensive experience includes the JOBS Act and Dodd-Frank Act, and he has led extensive efforts to help foreign banks establish programs for complying with the Volcker Rule. He also represents individuals and entities facing investigations by the CFTC or derivatives exchanges.

Previously, Daniel served as the Vice President and Regional Enforcement Director of the Financial Industry Regulatory Authority (FINRA), where he oversaw 70 lawyers across 15 offices responsible for bringing up to 900 disciplinary actions annually against broker-dealer firms, registered representatives and associated persons. This included many of FINRA’s most significant nationwide enforcement actions, including actions and sweeps involving mutual fund breakpoints, structured products sales practices and supervision, and private placement due diligence and disclosure.

In his 12 years at the SEC, Daniel served as Assistant Director in the Division of Enforcement, where he supervised federal securities investigations of insider trading (including the investigation that resulted in the seminal case US v. O’Hagan), market manipulation, financial fraud and accounting misconduct. In nine years with the CFTC, he served as Deputy Director of Enforcement, with responsibility for oversight of the agency’s Enforcement Division.  In that role, he supervised significant actions regarding market manipulation, trade practices, commodity trading advisor practices and foreign exchange dealer practices.

An oft-quoted authority on complex financial, legal and business issues, Daniel is frequently sought after to speak and write on the important issues confronting financial institutions, including broker-dealer sales practices and compliance, complex products, ETFs, the Volcker Rule, derivatives, cryptocurrency, cybersecurity, and anti-money laundering. He is Co-chair of the ABA SEC Enforcement Subcommittee and a member of the Editorial Advisory Board of the Journal of Investment Compliance.

ENFORCEMENT AND LITIGATION

  • Commodities Exchange Investigation. Represented an energy marketing firm in a Chicago Mercantile Exchange investigation of possible market manipulation through physical and swaps trading. The CME closed the investigation without action.

  • Derivatives Exchange Investigation. Represents an energy trader in an investigation of possible disruptive trading practices in natural gas trading.

  • SEC Investigation. Represents an ETF promoter in an SEC investigation regarding various trading and ‘40 Act issues.

  • SEC Investigation. Represents a former Chief Financial Officer of a public company in an SEC investigation and related class actions regarding financial reporting.

  • SEC Investigation. Represents a Regional Center in an SEC investigation of EB-5 offerings.

  • SEC Investigation. Represented a Chief Credit Officer of a financial institution in an investigation regarding accounting for impaired real estate loans.

  • SEC Investigation. Represented an individual in an investigation regarding insider trading and improper tipping. The SEC did not bring action against Dan’s client.

  • SEC Investigation. Represented an individual in negotiating the settlement of a financial reporting case, with a focus on clawback issues under Sarbanes-Oxley.

  • LIBOR Investigation. Represented a former trader in the Department of Justice’s LIBOR investigation.

  • ISDAfix Investigation. Represented a broker-dealer supervisor in a FINRA investigation regarding supervision of the ISDAfix rate-settting process at a large bank.

  • ISDAfix Investigation. Represented several former and current traders in the CFTC’s investigation regarding the ISDAfix benchmark rate.

  • FINRA Registration. Represented an individual in successfully removing a NYSE bar from association with a broker-dealer.

  • FINRA Arbitration. Represents a broker-dealer in an arbitration related to excessive mark-ups on fixed income securities transactions.

  • FINRA Arbitration. Defended a foreign bank in a FINRA arbitration brought by a trading client who alleged failure to deliver on a substantial fixed income transaction.

  • FINRA Enforcement – ETF Trading issues. Represents a broker-dealer in a FINRA investigation regarding ETF creation and redemption processes.

  • FINRA Enforcement – Research Analyst Issues. Represented several broker-dealers in FINRA investigations related to research analyst issues raised by the Dodd-Frank Act and the JOBS Act.

  • FINRA Enforcement – Form U-4 Disclosure. Represented individual brokers in several FINRA investigations regarding the failure to disclose liens and bankruptcies on the broker’s Form U-4.

  • FINRA Enforcement – Private Equity. Represented a private equity fund accused by FINRA of failing to provide adequate disclosure to investors, and negotiated a substantially reduced sanction.

  • FINRA Enforcement – AML Action. Negotiated a substantially reduced sanction on behalf of a broker-dealer in a case alleging several AML violations as well as other violations.

  • Expert Witness – Broker-Dealer Compliance. Served as an expert witness regarding the scope and execution of the duties of a broker-dealer chief compliance officer.

  • Expert Witness – Broker-Dealer Registration. Served as an expert witness in a private action concerning registration requirements for individuals marketing ETFs on behalf of a broker-dealer.

COUNSELING

  • Volcker Rule. Advised five different domestic and foreign banking entities on the establishment and implementation of Volcker Rule Compliance Programs.

  • EB-5 Visa Program. Advised real estate developers and issuers regarding requirements of the EB-5 visa program administered by the United States Citizenship and Immigration Services.

  • Securities Political Intelligence and Research procedures. Drafting compliance procedures for a firm engaged in providing political intelligence.

Posts by: Daniel Nathan

In the Matter of Tomahawk Exploration LLC: No Such Thing as a Free Launch

The issuance of digital tokens in exchange for services rather than money still can constitute an offering of securities, according to findings recently made by the Securities and Exchange Commission in a settled enforcement action, In the Matter of Tomahawk Exploration LLC and David Thompson Laurance, Securities Act Rel. No. 33-10530, Exchange Act Rel. No. 34-83839, Admin. Proc. File No. 3-18641 (Aug. 14, 2018). Tomahawk Exploration LLC offered and distributed digital assets in the form of tokens called “Tomahawkcoins,” or “TOM tokens” through an initial coin offering (“ICO”). The company offered a “Bounty Program,” whereby Tomahawk dedicated 200,000 TOM tokens to pay third parties, offering between 10 and 4,000 TOM tokens in exchange for the following activities:

  • marketing efforts;
  • making requests to list TOM tokens on token trading platforms;
  • promoting TOM tokens on blogs and online forums such as Twitter or Facebook;
  • creating professional picture file designs;
  • YouTube videos, other promotional materials; and
  • online promotional efforts that targeted potential investors and directed them to Tomahawk’s offering materials.

According to the SEC’s Cease-and-Desist Order, between July and September 2017, Tomahawk issued more than 80,000 TOM tokens as bounties to approximately forty wallet holders on Tomahawk’s decentralized platform in exchange for the activities listed above. The decentralized platform on which Tomahawk issued the TOM tokens was publicly accessible to U.S. persons and others throughout the offering period.

Based on the specific facts and circumstances outlined above, the SEC reasoned that the TOM tokens were considered securities because they were investment contracts under SEC v. W.J. Howey Co., 328 U.S. 293 (1946), and its progeny, including the cases discussed by the SEC in its Report Of Investigation Pursuant To Section 21(a) Of The Securities Exchange Act Of 1934: The DAO (Exchange Act Rel. No. 81207) (July 25, 2017). The SEC applied the Howey test and stated that “[t]he TOM tokens were offered in exchange for the investment of money or other contributions of value” and that “[t]he representations in the online offering materials created an expectation of profits derived from the efforts of others, namely from the oil exploration and production operations conducted by Tomahawk and Laurance and from the opportunity to trade TOM tokens on a secondary trading platform.” In addition, the Tomahawkcoins also represented a transferable share or option on an equity share of Tomahawk Exploration LLC, which would be considered securities under the federal securities laws under Section 2(a)(1) of the Securities Act of 1933 (the “Securities Act”) and Sections 3(a)(10) and 3(a)(11) of the Securities Exchange Act of 1934 (the “Exchange Act”). The SEC also determined that the TOM tokens were equity securities because they were “penny stocks” under Section 3(a)(51) of the Exchange Act and Rule 3a51-1 thereunder.

Of particular note is the SEC Staff’s argument that the TOM tokens issued under the Bounty Program constituted an offer and sale of securities because the respondents provided TOM tokens to investors in exchange for investors’ services designed to advance the company’s economic interests and foster a trading market for its securities. Paragraphs 33 and 34 of the Order explained that distributing TOM tokens in exchange for the provision of services could still be deemed an offer of securities under Section 2(a)(3) of the Securities Act because it involved “an attempt or offer to dispose of, or solicitation of an offer to buy, a security or interest in a security, for value.” The SEC found that notwithstanding “[t]he lack of monetary consideration for purportedly ‘free’ shares,” the issuance of the TOM tokens as a “gift” of a security through the Bounty Program constituted a “sale” or “offer to sell” within the meaning of the Securities Act as stated in SEC v. Sierra Brokerage Servs., Inc., 608 F. Supp. 2d 923, 940–43 (S.D. Ohio 2009), aff’d, 712 F.3d 321 (6th Cir. 2013).

Consequently, the SEC found that the Respondents violated the securities registration provisions, Sections 5(a) and 5(c) of the Securities Act, prohibiting the selling or offering of a security through any means or instrument of transportation and communication in interstate commerce or the mails without an effective registration statement or qualifying exemption. The SEC also found violations of the antifraud provisions, Section 10(b) of the Exchange Act and Rule 10b-5(b) promulgated thereunder, arising from materially false and misleading statements found on Tomahawk’s ICO website and in its white paper.

Tomahawk is a new application of the principle that the issuance of “free” securities for some economic benefit would still constitute a sale of, or an offer to sell, securities. The SEC previously applied this principle in 1999, when SEC Staff issued at least three No-Action Letters indicating its view that Internet stock giveaways would constitute unlawful “sales” of securities if not subject to a registration statement or a valid exemption from registration:

  • In the Vanderkam & Sanders No-Action Letter, SEC No-Action Letter 1999 WL 38281 (Jan. 27, 1999), the SEC Staff opined that “the issuance of securities in consideration of a person’s registration on or visit to an issuer’s Internet site would be an event of sale.” According to the Letter, such an issuance would violate Section 5 of the Securities Act unless it was the subject of a registration statement or a valid exemption from registration.
  • In the Simplystocks.com No-Action Letter, SEC No-Action Letter, 1999 WL 51836 (Feb. 4, 1999), Simplystocks proposed to distribute free stocks randomly to members of a pool of entrants who logged in to Simplystocks’ website and provided their name, address, social security number, phone number and email address and chose a login name and password. Visitors would receive one entry into the stock pool for each day they logged in to the Simplystocks website. The SEC Staff were of the opinion that the Simplystocks.com stock giveaway would be an event of sale within the meaning of Section 2(a)(3) of the Securities Act and must be the subject of a registration statement or a valid exemption from registration.
  • In the Andrew Jones and James Rutten No-Action Letter, SEC No-Action Letter, 1999 WL 377873 (Jun. 8, 1999), the SEC Staff opined that the issuance of three free shares of common stock to the first one million people who register with the issuer to receive the shares, whether or not through the issuer’s Internet site, and the issuance of one additional share (up to a specified maximum) to each shareholder who referred others who also become a shareholder, was an event of sale within Section 2(a)(3) of the Securities Act. The Staff opined that such an issuance would be unlawful under Section 5 of the Securities Act unless registered or exempt from registration.

Tomahawk additionally highlights the potential issues for “air drops” and the “free” distribution of tokens to recipients, as well as a further consideration to the “investment of money” prong under the Howey analysis. Moreover, the fraudulent statements found in the ICO website and white paper further drives home the point that any and all documentation intended to be disseminated, whether in the public or private spheres, should be carefully reviewed and vetted by counsel. As with all matters in the blockchain and crypto-space, all facts and circumstances related to the distribution of digital assets must be carefully considered prior to and when conducting any type of distribution or sale to recipients and users.

The SEC’s Authority to Enforce the Bank Secrecy Act is Challenged

In the past few years, the SEC has become increasingly active in bringing enforcement actions based on broker-dealers’ alleged failures to comply with requirements of the Bank Secrecy Act (BSA), in particular that requirement that they file “Suspicious Activity Reports,” or “SARs.” The SEC’s authority to bring such actions, however, has never been established by statute or appellate authority, and is being challenged in a petition for a writ of mandamus currently pending in the Second Circuit.  Though the procedural posture of that case makes it an unlikely vehicle for resolving the question, the issue it raises is likely to recur so long as the SEC continues to bring such enforcement actions despite its lack of any clear authority to do so.  Practitioners should be aware of this open issue so that it can be properly raised and preserved in BSA enforcement actions brought by the SEC.

The SEC’s Lack of Civil Penalty Authority under the BSA

The Bank Secrecy Act, enacted in 1970 to combat money-laundering, gives general examination and enforcement authority to the Secretary of the Treasury.  The Treasury Secretary is also authorized to “delegate duties and powers … to an appropriate supervising agency.”  31 U.S.C. § 5318.  By regulation, Treasury has delegated “[a]uthority to examine institutions to determine compliance with the requirements of” the BSA to various other agencies. 31 C.F.R. § 1010.810(b).  With respect to securities broker-dealers, such “authority to examine” has been delegated to the SEC. 31 C.F.R. § 1010.810(b)(6).  However, Treasury has kept “[a]uthority for the imposition of civil penalties” with the Financial Crimes Enforcement Network, or FinCEN, which is a bureau of Treasury.  31 C.F.R. § 1010.810(d).

Despite its lack of delegated authority, for more than a decade the SEC has initiated civil enforcement actions based on alleged failure of securities broker-dealers to comply with BSA requirements. In recent years, these enforcement actions have become more frequent, and have also changed in nature. Earlier enforcement actions typically focused on the requirement that broker-dealers establish and comply with a written Customer Identification Program. And in those cases where the SEC based its enforcement action on the requirement that broker-dealers file SARs, it was generally in circumstances where the broker-dealer in question failed to file any SARs at all for a protracted period. More recent enforcement actions, however, have challenged the adequacy of SARs that broker-dealers actually did file.

In these proceedings, the SEC has based its asserted enforcement authority under the BSA on Exchange Act Section 17(a), which allows the SEC to require that broker-dealers “make and keep for prescribed periods such records” that the Commission requires. Under that provision, the SEC promulgated Exchange Act Rule 17a-8—17 C.F.R. § 240.17a-8—which cross-references the regulations promulgated by the Treasury Department under the BSA and requires that securities broker-dealers comply with them.  In effect, then, the SEC has invoked its books-and-records authority as a means to assert for itself authority to enforce the requirements of the BSA.

The Pending SEC v. Alpine Securities Corp. Litigation

Although the SEC has been bringing enforcement actions based on securities broker-dealers’ alleged failures to comply with BSA requirements for more than a decade, its authority to do so was not challenged until recently.  The SEC brought a BSA enforcement action against Alpine Securities Corp. in the summer of 2017 in the Southern District of New York. That suit is representative of the SEC’s more recent BSA enforcement actions. According to the SEC’s allegations, Alpine did have a BSA compliance program, and did file thousands of SARs. The SEC, however, alleges that the SARs that Alpine filed were inadequate in various ways. And as in other BSA enforcement actions brought by the SEC, the agency alleged that these inadequate SARs violated Section 17(a) of the Exchange Act and Rule 17a-8.

In early 2018, Alpine moved for summary judgment, arguing that the SEC lacks authority to bring enforcement actions seeking civil penalties for alleged violations of the Bank Secrecy Act.  Alpine argued that the BSA expressly delegates authority to bring civil enforcement actions to the Treasury Secretary, and that the Treasury Secretary—while delegating authority to examine various institutions for BSA compliance to various other agencies—retained enforcement authority for itself.  Alpine contended that the SEC’s interpretation of the “books and record” provision as giving it the power to bring its own BSA enforcement actions was contrary to Congressional command, and that the SEC was improperly attempting to “bootstrap” itself into an area where it lacked jurisdiction.

The district court judge—Judge Denise Cote—denied Alpine’s motion. First, the court concluded that Alpine was wrong to characterize the SEC’s suit as seeking to enforce the BSA, because the SEC in fact brought the suit under Section 17(a) and Rule 17a-8. Second, the court rejected Alpine’s challenge to the SEC’s interpretation of Section 17(a) of the Exchange Act.  Applying the two-step framework from Chevron v. Natural Resources Defense Council, 467 U.S. 837 (1984), the court concluded that Rule 17a-8, which requires compliance with certain BSA regulations, is a reasonable interpretation of Exchange Act Section 17(a).  The court further observed that “neither the Exchange Act nor the BSA expressly precludes joint regulatory authority by FinCEN and the SEC over the reporting of potentially suspicious transactions.”

Alpine moved for reconsideration of the court’s order or, in the alternative, for certification of an interlocutory appeal. The court denied both motions.  On June 22, 2018, Alpine filed a petition for a writ of mandamus in the Second Circuit, again arguing that the BSA expressly delegates enforcement authority to Treasury, and such authority cannot be usurped by the SEC. On July 9, the SEC filed an opposition to the mandamus petition.

Implications for White-Collar and Securities Practitioners

In light of the high bar for obtaining a writ of mandamus, the chances that the Second Circuit will grant the relief Alpine requests are likely low.  The reasoning and conclusion of the district court’s decision, however, are vulnerable to attack.  The district court focused its analysis almost exclusively on Exchange Act Section 17(a) and Rule 17a-8, and rejected Alpine’s challenge based on its determination that the SEC clearly has authority to impose record-keeping and production requirements on broker-dealers.  In FDA v. Brown & Williamson, however, the Supreme Court emphasized that, “[i]n determining whether Congress has specifically addressed the question at issue, a reviewing court should not confine itself to examining a particular statutory provision in isolation.”  529 U.S. 120, 132 (2000).  Rather, courts must “interpret the statute as a symmetrical and coherent regulatory scheme,” and must also take into account how one statute “may be affected by other Acts.”  Id. at 133 (internal citations omitted).  Similarly, the Second Circuit has held that where an Act of Congress “specifically and unambiguously targets” a particular issue and “unambiguously” gives enforcement authority to a particular agency, another agency’s “assertion of concurrent jurisdiction rings a discordant tone with the regulatory structure created by Congress.”  Nutritional Health All. v. FDA, 318 F.3d 92, 104 (2d Cir. 2003).

As long as the SEC continues to bring BSA enforcement actions, it appears inevitable that at some point a court of appeals will be called upon to determine whether the SEC does, in fact, have such enforcement authority. White-collar and securities practitioners defending broker-dealers in SEC enforcement actions based on the alleged failure to file SARs or comply with other requirements of the BSA should raise the issue during the investigation process and again during court proceedings to ensure that it is preserved, and ask the court to certify the question for interlocutory appeal under 28 U.S.C. 1292(b) if the court determines that the SEC does have such authority.  Although the district judge in the Alpine Securities case refused to certify an interlocutory appeal, in light of the dearth of appellate case law on the issue and the fundamental nature of the challenge, other district judges may be willing to certify.

SEC Proposes a “Best Interest” Standard for Broker-Dealers

On April 18, 2018, the Securities and Exchange Commission proposed a set of rules and interpretations regarding the standard of conduct that broker-dealers owe to their investing customers, and reaffirming and clarifying the standard of conduct owed to customers by investment advisers.

The SEC’s proposal is the newest development in an ongoing effort to clearly define and determine the standards to which financial professionals are held. In 2010, the Dodd-Frank Act delegated authority to the SEC to propose a uniform fiduciary standard across all retail investment professionals. Rather than wait for the SEC to do so, however, in 2016 the Department of Labor (DOL) promulgated its own fiduciary rule. As previously discussed here, the U.S. Court of Appeals for the Fifth Circuit recently struck down the DOL rule.

According to SEC Chairman Jay Clayton, the Commission’s recent proposal is the outcome of extensive consideration and is intended to enhance investor protection by applying consistent standards of conduct to investment advisers and broker-dealers. The SEC’s proposal, spanning over 1,000 pages, has three main components:

Regulation Best Interest: First and foremost, the SEC proposal includes a new standard of conduct for broker-dealers that would be enacted through a set of regulations entitled, “Regulation Best Interest.” Although the term “Best Interest” is not defined in the proposal, the regulations would require a broker-dealer to act in the best interest of its retail customers when making investment recommendations, and prohibit it from putting its own financial interests first. To discharge this duty, a broker-dealer must comply with three specific obligations:

(1) Disclosure obligation – a broker-dealer must disclose key facts about its relationship with its customers, including material conflicts of interest.

(2) Care obligation – a broker-dealer must exercise reasonable diligence, care, skill and prudence to understand any recommended product, and have a reasonable basis to believe that a product and series of transactions are in the customer’s best interest.

(3) Conflict of interest obligation – a broker-dealer must establish, maintain and enforce policies and procedures to identify, disclose and mitigate or eliminate conflicts of interest.

Guidance for Investment Advisers: In addition to enhancing the standard of conduct for broker-dealers, the SEC reaffirmed its view that investment advisers owe their clients fiduciary duties. The SEC’s proposal seeks to gather, summarize and reaffirm existing guidance in one place.

Form CRS: The Commission also proposed a new disclosure document, Form CRS (Client or Customer Relationship Summary), which would provide retail investors with information regarding the nature of their relationship with their investment professional. The proposed Form CRS would be a standardized, short-form disclosure highlighting services offered, legal standards of conduct, possible customer fees, and certain conflicts of interest. In addition, the proposal limits a broker-dealer’s ability to identify itself as an “adviser” unless it is registered with the SEC as an investment adviser, so as not to cause confusion among investors.

Takeaways

In the wake of the controversy launched by Dodd-Frank and the DOL rule, and on the heels of the Fifth Circuit’s rejection of that rule, the SEC has taken a bold step in the direction of increased regulation of broker-dealers. The SEC’s proposal will undoubtedly impact the way broker-dealers make recommendations to their customers, although to what extent may depend on whether broker-dealers were already adapting to the DOL rule before it was overturned by the Fifth Circuit. The SEC will seek public comment on its proposal over the next 90 days, giving interested parties time to dig into the extensive materials. Indeed, several Commissioners acknowledged that questions about the applicable standards remain, suggesting that changes to the proposal will be forthcoming.

Fifth Circuit Vacates Department of Labor’s Fiduciary Rule

Last week, a divided panel of the U.S. Court of Appeals for the Fifth Circuit struck down the U.S. Department of Labor’s (“DOL”) “Fiduciary Rule,” a controversial measure that redefined exemptions to Employee Retirement Income Security Act of 1974 (“ERISA”) provisions concerning fiduciaries. The DOL’s rule, promulgated in April 2016, consisted of a package of seven interrelated rules, and it sparked controversy by redefining how brokers and other financial professionals serve consumers. First, the Fiduciary Rule reinterpreted the ERISA term “investment advice fiduciary,” heightening the fiduciary duty for these financial professionals to a “best interest” standard for their clients with ERISA plans and individual retirement accounts (“IRAs”). This “best interest” standard marked a significant departure from the prior standard for brokers, which required them to recommend investments that were merely “suitable” for their clients. Second, the Fiduciary Rule created a “Best Interest Contract Exemption,” which allowed financial professionals to avoid prohibited transactions penalties as long as they contractually affirmed their fiduciary status. READ MORE

Looking Out for Main Street: SEC Focuses on Retail, Cybersecurity and Cryptocurrency

The Commissioners and senior officials of the Securities and Exchange Commission (“SEC” or “Commission”) addressed the public on February 23-24 at the annual “SEC Speaks” conference in Washington, D.C. Throughout the conference, many speakers referred to the new energy that SEC Chairman Jay Clayton had brought to the Commission since his confirmation in May 2017. The speakers also seemed relieved that the SEC was finally operating with a full set of commissioners since the recent additions of Robert J. Jackson, Jr. and Hester M. Peirce. Clayton’s address introduced the main refrain of the conference: that the SEC under his leadership is focused on the long-term interests of Main Street investors. Other oft-repeated themes included the challenges presented by cybersecurity and the fast-paced developments in cryptocurrency and blockchain. To address these shifts in focus, the Enforcement division plans to add more resources to the retail, cybersecurity and cryptocurrency spaces.

Following are the key litigation and enforcement takeaways.

Main Street Investors

Commissioner Kara Stein picked up on Clayton’s Main Street investors focus when she asked whether increasingly complex and esoteric investments, such as product strategies and structures that utilize derivatives, were appropriate for retail investors. She explained that it was not a question whether the financial industry could develop and sell these products, but whether it should. She said it was not clear that financial professionals fully understood the products they were selling, and that even if brokers and advisers made disclosures regarding the potential outcomes and risks to investors, complete disclosures might not even be possible due to the products’ complexity. Both SEC and FINRA Enforcement have brought actions related to the sales practices of inverse and leveraged ETFs, as well as the purchase and sale of complex products. Stein opined that gatekeepers needed to remember the real people behind every account number when they were advising clients on how to handle these types of products.

Steven Peikin, Co-Director of the Division of Enforcement, described the SEC’s Share Class Selection Disclosure Initiative as one way in which Enforcement was trying to help Main Street investors. The Initiative was created to address the problem of investment advisers putting their clients into higher fee share classes when no fee or lower fee classes were available. The SEC is incentivizing advisers to self-report this issue by promising not to impose any penalties, and only requiring them to disgorge their profits to investors. Peikin encouraged investment advisers to take advantage of this opportunity, indicating that if the Commission learned that an adviser had engaged in this conduct and did not self-report, it would be subject to significant penalties. The Chief of the SEC’s Broker-Dealer Task Force shared that AML programs and SAR-filing obligations are also a priority for the Enforcement division and OCIE exams. READ MORE

FINRA Enforcement Head Explains Why Enforcement “Isn’t Rocket Science”

In a speech at the SIFMA AML Conference last week, FINRA Head of Enforcement Susan Schroeder openly explained the “straightforward framework” that Enforcement uses when making decisions about enforcement actions. The context for Schroeder’s speech was FINRA’s merger of two separate enforcement departments, resulting from FINRA head Robert Cook’s “listening tour” and FINRA’s recent self-evaluation, but Schroeder’s explanation appeared to be more of a response to broader industry complaints about FINRA Enforcement’s lack of consistency and transparency in its charging and sanctions decisions.

If that was Schroeder’s mission, she was successful. She identified the goals of enforcement actions, and justified FINRA’s use of its enforcement tool based upon harms to investors and perceived market risks. Overarching Schroeder’s speech was the principle that firms should know “what to expect from their regulator” so they know “how to shape their behavior in order to comply with the rules.” In this spirit of transparency, Schroeder identified the various principles or factors that FINRA Enforcement considers when evaluating enforcement actions and sanctions. Those principles should provide a vocabulary for firms and their counsel to assess and question FINRA’s enforcement activities.

Here are the principles in Schroeder’s own words:

Is this enforcement action appropriate? According to Schroeder, enforcement actions should be brought to “fix something that is broken or to prevent future misconduct, either by the same respondent or by another individual or firm.” Enforcement is not the only means FINRA has to fix something, and it is not always the “right tool” to use. To determine whether enforcement action is the appropriate regulatory response, FINRA will ask: READ MORE

SEC’s OCIE Announces 2018 Areas of Focus

On February 7, 2018 the SEC’s Office of Compliance Inspections and Examinations (OCIE) announced its 2018 National Exam Priorities. The priorities, formulated with input from the Chairman, Commissioners, SEC Staff and fellow regulators, are mostly unchanged from years past (New Year, Similar Priorities: SEC Announces 2017 OCIE Areas of Focus, Orrick.com). However, the publication itself is presented in a more formal wrapper that begins with a lengthy message from OCIE’s leadership team describing the Office’s role and guiding principles, including that they are risk-based, data-driven and transparent, and that they embrace innovation and new technology.

2018 Priorities

OCIE’s principal 2018 priority, not surprisingly, appears to be the protection of retail investors, including seniors and those saving for retirement. OCIE specifically stated that it will focus on the disclosure of investment fees and other compensation received by financial professionals; electronic investment advisors – sometimes known as “robo-advisors”; wrap fee programs in which investors are charged a single fee for bundled services; and never-before-examined investment advisors. As to the latter, OCIE indicated that in the most recent fiscal year, it examined approximately 15 percent of all investment advisors, up from 8 percent five years before. It remains to be seen whether that increasing trend will continue.

Noting that the cryptocurrency and initial coin offering (ICO) markets “present a number of risks for retail investors,” OCIE included them as a priority for the first time. Examiners will focus on whether financial professionals maintain adequate controls and safeguards over the assets, as well the disclosure of investment risks.

Other 2018 priorities are compliance and risks in critical market infrastructure; cybersecurity protections, which OCIE states are critical to the operation of our markets; and anti-money laundering programs. In addition, OCIE has prioritized its examinations of FINRA and MSRB to ensure that those entities continue to operate effectively as self-regulatory organizations subject to the SEC’s oversight. READ MORE

No Direct Cause, No Restitution

A recent federal appellate decision shows there are limits to the ability of a regulator to claim monetary sanctions for statutory violations. Last week the 11th Circuit held that investors whose losses were solely associated with registration violations by their fraudster traders were not entitled to a restitution award – because such losses had not been proximately caused by the registration violations.

In an enforcement action brought by the Commodity Futures Trading Commission, the 11th Circuit affirmed a Florida district court’s findings that two companies and their CEO committed fraud by falsely representing to some investors that they had purchased physical metals on their behalf (when they had actually purchased futures), and violated the registration requirements of the Commodities Exchange Act (CEA) by trading in futures without registering as futures commission merchants. The district court had awarded restitution for losses arising from both of these violations. While the 11th Circuit upheld the restitution award of approximately $1.5 million based on the fraudulent misrepresentation, it vacated the award of approximately $560,000 based on the failure to register, holding that this violation did not proximately cause the investors’ losses. READ MORE

Financial Derivatives Intermediaries Who Trade Virtual Currencies Face the NFA’s Enhanced Reporting Requirements

Derivatives regulators continue to take actions that pull virtual currencies – also known as digital currency or cryptocurrency, the best known of which is bitcoin – into their regulatory schemes. In December, the National Futures Association (NFA), the futures industry’s self-regulatory organization, issued three Notices to Members that expand the notification and reporting requirements for futures commission merchants (FCMs), introducing brokers (IBs), commodity pool operators (CPOs) and commodity trading advisers (CTAs) trading in virtual currencies and related derivatives. In issuing these directives, the NFA cited the fact that a number of CFTC-regulated trading venues were in the process of offering derivatives on virtual currency products and stated that it was expanding the notification and reporting requirements due to the volatility in the underlying virtual currency markets.

Specifically, the NFA’s notices:

  • direct each FCM for which NFA is the DSRO to immediately notify NFA if the firm decides to offer its customers or non-customers the ability to trade any virtual currency futures product. NFA also requires each FCM to report on its daily segregation reports the number of customers who traded a virtual currency futures contract (including closed out positions), the number of non-customers who traded a virtual currency futures contract (including closed out positions), and the gross open virtual currency futures positions (i.e. total open long positions, total open short positions);
  • direct each IB to immediately notify NFA if it solicits or accepts any orders in virtual currency derivatives. NFA also requires each IB that solicits or accepts orders for one or more virtual currency derivatives to notify NFA by amending its annual questionnaire, by answering this question: Does your firm solicit or accept orders involving a virtual currency derivative (e.g. a bitcoin future, option or swap)? In addition, starting with the current quarter, IBs that solicit or accept orders for virtual currency derivatives will also be required to report the number of accounts they introduced that executed one or more trades in a virtual currency derivative during each calendar quarter;
  • direct each CPO and CTA to immediately notify NFA if it executes a transaction involving any virtual currency (such as bitcoin) or virtual currency derivative (such as a bitcoin future, options or swap) on behalf of a pool or managed account. NFA’s Notice requires that CPOs and CTAs provide such notice by amending their annual questionnaire, to which NFA added questions that inquired, for CPOs, whether the firm operates a pool that has executed a transaction involving a virtual currency or virtual currency derivative and, for CTAs, whether the firm offers a trading program for managed account clients that have transacted in a virtual currency, or managed an account that transacted in a virtual currency derivative. In addition, beginning with the current quarter, the NFA is requiring CPOs and CTAs to report on a quarterly basis the number of their pools or managed accounts that executed at least one transaction involving a virtual currency or virtual currency derivative.

READ MORE