[{"id":1696,"date":"2018-09-11T16:33:56","date_gmt":"2018-09-11T20:33:56","guid":{"rendered":"http:\/\/blogs.orrick.com\/securities-litigation\/?p=1696"},"modified":"2018-09-11T16:33:56","modified_gmt":"2018-09-11T20:33:56","slug":"in-the-matter-of-tomahawk-exploration-llc-no-such-thing-as-a-free-launch","status":"publish","type":"post","link":"https:\/\/blogs.orrick.com\/securities-litigation\/2018\/09\/11\/in-the-matter-of-tomahawk-exploration-llc-no-such-thing-as-a-free-launch\/","title":{"rendered":"In the Matter of Tomahawk Exploration LLC: No Such Thing as a Free Launch"},"content":{"rendered":"<p>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, <em>In the Matter of Tomahawk Exploration LLC and David Thompson Laurance<\/em>, Securities Act Rel. No. 33-10530, Exchange Act Rel. No. 34-83839, Admin. Proc. File No. 3-18641 (Aug. 14, 2018).\u00a0Tomahawk Exploration LLC offered and distributed digital assets in the form of tokens called &#8220;Tomahawkcoins,&#8221; or &#8220;TOM tokens&#8221; through an initial coin offering (&#8220;ICO&#8221;). The company offered a &#8220;Bounty Program,&#8221; whereby Tomahawk dedicated 200,000 TOM tokens\u00a0to pay third parties, offering between 10 and 4,000 TOM tokens\u00a0in exchange for the following activities:<\/p>\n<ul>\n<li>marketing efforts;<\/li>\n<li>making requests to list TOM tokens on token trading platforms;<\/li>\n<li>promoting TOM tokens on blogs and online forums such as Twitter or Facebook;<\/li>\n<li>creating professional picture file designs;<\/li>\n<li>YouTube videos, other promotional materials; and<\/li>\n<li>online promotional efforts that targeted potential investors and directed them to Tomahawk&#8217;s offering materials.<\/li>\n<\/ul>\n<p>According to the SEC&#8217;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&#8217;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.<\/p>\n<p>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 <em>SEC v. W.J. Howey Co.<\/em>, 328 U.S. 293 (1946), and its progeny, including the cases discussed by the SEC in its <em>Report Of Investigation Pursuant To Section 21(a) Of The Securities Exchange Act Of 1934: The DAO<\/em> (Exchange Act Rel. No. 81207) (July 25, 2017). The SEC applied the <em>Howey<\/em> test and stated that &#8220;[t]he TOM tokens were offered in exchange for the investment of money or other contributions of value&#8221; and that &#8220;[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\u00a0on a secondary trading platform.&#8221; 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 &#8220;Securities Act&#8221;) and Sections 3(a)(10) and 3(a)(11) of the Securities Exchange Act of 1934 (the &#8220;Exchange Act&#8221;). The SEC also determined that the TOM tokens were equity securities because they were &#8220;penny stocks&#8221; under Section 3(a)(51) of the Exchange Act and Rule 3a51-1 thereunder.<\/p>\n<p>Of particular note is the SEC Staff&#8217;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&#8217; services designed to advance the company&#8217;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 &#8220;an attempt or offer to dispose of, or solicitation of an offer to buy, a security or interest in a security, for value.&#8221; The SEC found that notwithstanding &#8220;[t]he lack of monetary consideration for purportedly &#8216;free&#8217; shares,&#8221; the issuance of the TOM tokens as a &#8220;gift&#8221; of a security through the Bounty Program constituted a &#8220;sale&#8221; or &#8220;offer to sell&#8221; within the meaning of the Securities Act as stated in <em>SEC v. Sierra Brokerage Servs., Inc.<\/em>, 608 F. Supp. 2d 923, 940\u201343 (S.D. Ohio 2009), aff&#8217;d, 712 F.3d 321 (6th Cir. 2013).<\/p>\n<p>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&#8217;s ICO website and in its white paper.<\/p>\n<p><em>Tomahawk<\/em> is a new application of the principle that the issuance of &#8220;free&#8221; 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 &#8220;sales&#8221; of securities if not subject to a registration statement or a valid exemption from registration:<\/p>\n<ul>\n<li>In the <em>Vanderkam &amp; Sanders<\/em> No-Action Letter, SEC No-Action Letter 1999 WL 38281 (Jan. 27, 1999), the SEC Staff opined that &#8220;the issuance of securities in consideration of a person&#8217;s registration on or visit to an issuer&#8217;s Internet site would be an event of sale.&#8221; 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.<\/li>\n<li>In the <em>Simplystocks.com<\/em> 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&#8217; 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.<\/li>\n<li>In the <em>Andrew Jones and James Rutten<\/em> 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&#8217;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.<\/li>\n<\/ul>\n<p><em>Tomahawk<\/em> additionally highlights the potential issues for &#8220;air drops&#8221; and the &#8220;free&#8221; distribution of tokens to recipients, as well as a further consideration to the &#8220;investment of money&#8221; prong under the <em>Howey<\/em> 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.<\/p>\n<!-- AddThis Advanced Settings generic via filter on the_content --><!-- AddThis Share Buttons generic via filter on the_content -->","protected":false},"excerpt":{"rendered":"<p>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. [&hellip;]<!-- AddThis Advanced Settings generic via filter on get_the_excerpt --><!-- AddThis Share Buttons generic via filter on get_the_excerpt --><\/p>\n","protected":false},"author":759,"featured_media":1698,"comment_status":"closed","ping_status":"closed","sticky":false,"template":"","format":"standard","meta":{"footnotes":""},"categories":[46,1791],"tags":[1447,1832,1860,1859],"coauthors":[1829,1858],"class_list":["post-1696","post","type-post","status-publish","format-standard","has-post-thumbnail","hentry","category-sec","category-securities-litigation","tag-blockchain","tag-cryptocurrency","tag-tom-tokens","tag-tomahawk-exploration-llc"],"_links":{"self":[{"href":"https:\/\/blogs.orrick.com\/securities-litigation\/wp-json\/wp\/v2\/posts\/1696","targetHints":{"allow":["GET"]}}],"collection":[{"href":"https:\/\/blogs.orrick.com\/securities-litigation\/wp-json\/wp\/v2\/posts"}],"about":[{"href":"https:\/\/blogs.orrick.com\/securities-litigation\/wp-json\/wp\/v2\/types\/post"}],"author":[{"embeddable":true,"href":"https:\/\/blogs.orrick.com\/securities-litigation\/wp-json\/wp\/v2\/users\/759"}],"replies":[{"embeddable":true,"href":"https:\/\/blogs.orrick.com\/securities-litigation\/wp-json\/wp\/v2\/comments?post=1696"}],"version-history":[{"count":0,"href":"https:\/\/blogs.orrick.com\/securities-litigation\/wp-json\/wp\/v2\/posts\/1696\/revisions"}],"wp:featuredmedia":[{"embeddable":true,"href":"https:\/\/blogs.orrick.com\/securities-litigation\/wp-json\/wp\/v2\/media\/1698"}],"wp:attachment":[{"href":"https:\/\/blogs.orrick.com\/securities-litigation\/wp-json\/wp\/v2\/media?parent=1696"}],"wp:term":[{"taxonomy":"category","embeddable":true,"href":"https:\/\/blogs.orrick.com\/securities-litigation\/wp-json\/wp\/v2\/categories?post=1696"},{"taxonomy":"post_tag","embeddable":true,"href":"https:\/\/blogs.orrick.com\/securities-litigation\/wp-json\/wp\/v2\/tags?post=1696"},{"taxonomy":"author","embeddable":true,"href":"https:\/\/blogs.orrick.com\/securities-litigation\/wp-json\/wp\/v2\/coauthors?post=1696"}],"curies":[{"name":"wp","href":"https:\/\/api.w.org\/{rel}","templated":true}]}},{"id":1692,"date":"2018-07-10T16:38:23","date_gmt":"2018-07-10T20:38:23","guid":{"rendered":"http:\/\/blogs.orrick.com\/securities-litigation\/?p=1692"},"modified":"2021-04-12T12:26:22","modified_gmt":"2021-04-12T16:26:22","slug":"the-secs-authority-to-enforce-the-bank-secrecy-act-is-challenged","status":"publish","type":"post","link":"https:\/\/blogs.orrick.com\/securities-litigation\/2018\/07\/10\/the-secs-authority-to-enforce-the-bank-secrecy-act-is-challenged\/","title":{"rendered":"The SEC&#8217;s Authority to Enforce the Bank Secrecy Act is Challenged"},"content":{"rendered":"<p>In the past few years, the SEC has become increasingly active in bringing enforcement actions based on broker-dealers&#8217; alleged failures to comply with requirements of the Bank Secrecy Act (BSA), in particular that requirement that they file &#8220;Suspicious Activity Reports,&#8221; or &#8220;SARs.&#8221; The SEC&#8217;s authority to bring such actions, however, has never been established by statute or appellate authority, and is being challenged in a <a href=\"https:\/\/reaction.orrick.com\/rs\/ct.aspx?ct=24F76F14D6E645A9CCDD89ACD4249410DFF55590E9A534EC72DD4C4F0\">petition for a writ of mandamus<\/a> currently pending in the Second Circuit.\u00a0 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.\u00a0 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.<\/p>\n<p><u>The SEC&#8217;s Lack of Civil Penalty Authority under the BSA<\/u><\/p>\n<p>The Bank Secrecy Act, enacted in 1970 to combat money-laundering, gives general examination and enforcement authority to the Secretary of the Treasury.\u00a0 The Treasury Secretary is also authorized to &#8220;delegate duties and powers \u2026 to an appropriate supervising agency.&#8221; \u00a031 U.S.C. \u00a7 5318. \u00a0By regulation, Treasury has delegated &#8220;[a]uthority to examine institutions to determine compliance with the requirements of&#8221; the BSA to various other agencies. 31 C.F.R. \u00a7 1010.810(b).\u00a0 With respect to securities broker-dealers, such &#8220;authority to examine&#8221; has been delegated to the SEC. 31 C.F.R. \u00a7 1010.810(b)(6).\u00a0 However, Treasury has kept &#8220;[a]uthority for the imposition of civil penalties&#8221; with the Financial Crimes Enforcement Network, or FinCEN, which is a bureau of Treasury.\u00a0 31 C.F.R. \u00a7 1010.810(d).<\/p>\n<p>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.<\/p>\n<p>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 &#8220;make and keep for prescribed periods such records&#8221; that the Commission requires. Under that provision, the SEC promulgated Exchange Act Rule 17a-8\u201417 C.F.R. \u00a7 240.17a-8\u2014which cross-references the regulations promulgated by the Treasury Department under the BSA and requires that securities broker-dealers comply with them.\u00a0 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.<\/p>\n<p><u>The Pending <em>SEC v. Alpine Securities Corp.<\/em> Litigation<\/u><\/p>\n<p>Although the SEC has been bringing enforcement actions based on securities broker-dealers&#8217; alleged failures to comply with BSA requirements for more than a decade, its authority to do so was not challenged until recently.\u00a0 The SEC brought a <a href=\"https:\/\/reaction.orrick.com\/rs\/ct.aspx?ct=24F76F14D6E645A9CCDD89ACD4249410DFF555A2DF90212\">BSA enforcement action<\/a> against Alpine Securities Corp. in the summer of 2017 in the Southern District of New York. That suit is representative of the SEC&#8217;s more recent BSA enforcement actions. According to the SEC&#8217;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.<\/p>\n<p>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. \u00a0Alpine argued that the BSA expressly delegates authority to bring civil enforcement actions to the Treasury Secretary, and that the Treasury Secretary\u2014while delegating authority to <em>examine<\/em> various institutions for BSA compliance to various other agencies\u2014retained<em> enforcement<\/em> authority for itself. \u00a0Alpine contended that the SEC&#8217;s interpretation of the &#8220;books and record&#8221; 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 &#8220;bootstrap&#8221; itself into an area where it lacked jurisdiction.<\/p>\n<p>The district court judge\u2014Judge Denise Cote\u2014denied Alpine&#8217;s motion. First, the court concluded that Alpine was wrong to characterize the SEC&#8217;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&#8217;s challenge to the SEC&#8217;s interpretation of Section 17(a) of the Exchange Act. \u00a0Applying the two-step framework from <em>Chevron v. Natural Resources Defense Council<\/em>, 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). \u00a0The court further observed that &#8220;neither the Exchange Act nor the BSA expressly precludes joint regulatory authority by FinCEN and the SEC over the reporting of potentially suspicious transactions.&#8221;<\/p>\n<p>Alpine moved for reconsideration of the court&#8217;s order or, in the alternative, for certification of an interlocutory appeal. The court denied both motions. \u00a0On June 22, 2018, Alpine filed a <a href=\"https:\/\/reaction.orrick.com\/rs\/ct.aspx?ct=24F76F14D6E645A9CCDD89ACD4249410DFF55590E9A534EC72DD4C4F0\">petition for a writ of mandamus<\/a> 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 <a href=\"https:\/\/reaction.orrick.com\/rs\/ct.aspx?ct=24F76F14D6E645A9CCDD89ACD4249410DFF5558FFCA132EB72C64B5C50C61\">opposition to the mandamus petition<\/a>.<\/p>\n<p><u>Implications for White-Collar and Securities Practitioners<\/u><\/p>\n<p>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. \u00a0The reasoning and conclusion of the district court&#8217;s decision, however, are vulnerable to attack. \u00a0The district court focused its analysis almost exclusively on Exchange Act Section 17(a) and Rule 17a-8, and rejected Alpine&#8217;s challenge based on its determination that the SEC clearly has authority to impose record-keeping and production requirements on broker-dealers. \u00a0In <em>FDA v. Brown &amp; Williamson<\/em>, however, the Supreme Court emphasized that, &#8220;[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.&#8221; \u00a0529 U.S. 120, 132 (2000).\u00a0 Rather, courts must &#8220;interpret the statute as a symmetrical and coherent regulatory scheme,&#8221; and must also take into account how one statute &#8220;may be affected by other Acts.&#8221; \u00a0<em>Id. <\/em>at 133 (internal citations omitted).\u00a0 Similarly, the Second Circuit has held that where an Act of Congress &#8220;specifically and unambiguously targets&#8221; a particular issue and &#8220;unambiguously&#8221; gives enforcement authority to a particular agency, another agency&#8217;s &#8220;assertion of concurrent jurisdiction rings a discordant tone with the regulatory structure created by Congress.&#8221; \u00a0<em>Nutritional Health All. v. FDA<\/em>, 318 F.3d 92, 104 (2d Cir. 2003).<\/p>\n<p>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.\u00a0 Although the district judge in the <em>Alpine Securities <\/em>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.<\/p>\n<!-- AddThis Advanced Settings generic via filter on the_content --><!-- AddThis Share Buttons generic via filter on the_content -->","protected":false},"excerpt":{"rendered":"<p>In the past few years, the SEC has become increasingly active in bringing enforcement actions based on broker-dealers&#8217; alleged failures to comply with requirements of the Bank Secrecy Act (BSA), in particular that requirement that they file &#8220;Suspicious Activity Reports,&#8221; or &#8220;SARs.&#8221; The SEC&#8217;s authority to bring such actions, however, has never been established by [&hellip;]<!-- AddThis Advanced Settings generic via filter on get_the_excerpt --><!-- AddThis Share Buttons generic via filter on get_the_excerpt --><\/p>\n","protected":false},"author":477,"featured_media":1600,"comment_status":"closed","ping_status":"closed","sticky":false,"template":"","format":"standard","meta":{"footnotes":""},"categories":[764,46],"tags":[1853,1852,1061,1854,1855,534],"coauthors":[1132,1829,1845,1727,1856],"class_list":["post-1692","post","type-post","status-publish","format-standard","has-post-thumbnail","hentry","category-client-alert","category-sec","tag-bank-secrecy-act","tag-bsa","tag-fincen","tag-sars","tag-sec-v-alpine-securities-corp","tag-securities-and-exchange-commission"],"_links":{"self":[{"href":"https:\/\/blogs.orrick.com\/securities-litigation\/wp-json\/wp\/v2\/posts\/1692","targetHints":{"allow":["GET"]}}],"collection":[{"href":"https:\/\/blogs.orrick.com\/securities-litigation\/wp-json\/wp\/v2\/posts"}],"about":[{"href":"https:\/\/blogs.orrick.com\/securities-litigation\/wp-json\/wp\/v2\/types\/post"}],"author":[{"embeddable":true,"href":"https:\/\/blogs.orrick.com\/securities-litigation\/wp-json\/wp\/v2\/users\/477"}],"replies":[{"embeddable":true,"href":"https:\/\/blogs.orrick.com\/securities-litigation\/wp-json\/wp\/v2\/comments?post=1692"}],"version-history":[{"count":0,"href":"https:\/\/blogs.orrick.com\/securities-litigation\/wp-json\/wp\/v2\/posts\/1692\/revisions"}],"wp:featuredmedia":[{"embeddable":true,"href":"https:\/\/blogs.orrick.com\/securities-litigation\/wp-json\/wp\/v2\/media\/1600"}],"wp:attachment":[{"href":"https:\/\/blogs.orrick.com\/securities-litigation\/wp-json\/wp\/v2\/media?parent=1692"}],"wp:term":[{"taxonomy":"category","embeddable":true,"href":"https:\/\/blogs.orrick.com\/securities-litigation\/wp-json\/wp\/v2\/categories?post=1692"},{"taxonomy":"post_tag","embeddable":true,"href":"https:\/\/blogs.orrick.com\/securities-litigation\/wp-json\/wp\/v2\/tags?post=1692"},{"taxonomy":"author","embeddable":true,"href":"https:\/\/blogs.orrick.com\/securities-litigation\/wp-json\/wp\/v2\/coauthors?post=1692"}],"curies":[{"name":"wp","href":"https:\/\/api.w.org\/{rel}","templated":true}]}},{"id":1684,"date":"2018-04-20T15:45:47","date_gmt":"2018-04-20T19:45:47","guid":{"rendered":"http:\/\/blogs.orrick.com\/securities-litigation\/?p=1684"},"modified":"2018-04-20T15:45:47","modified_gmt":"2018-04-20T19:45:47","slug":"sec-proposes-a-best-interest-standard-for-broker-dealers","status":"publish","type":"post","link":"https:\/\/blogs.orrick.com\/securities-litigation\/2018\/04\/20\/sec-proposes-a-best-interest-standard-for-broker-dealers\/","title":{"rendered":"SEC Proposes a \u201cBest Interest\u201d Standard for Broker-Dealers"},"content":{"rendered":"<p>On April 18, 2018, the Securities and Exchange Commission proposed a <a href=\"https:\/\/www.sec.gov\/news\/press-release\/2018-68\">set of rules<\/a> 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.<\/p>\n<p>The SEC\u2019s 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 <a href=\"https:\/\/blogs.orrick.com\/securities-litigation\/2018\/03\/23\/fifth-circuit-vacates-department-of-labors-fiduciary-rule\/\">here<\/a>, the U.S. Court of Appeals for the Fifth Circuit recently struck down the DOL rule.<\/p>\n<p>According to SEC Chairman Jay Clayton, the Commission\u2019s 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\u2019s proposal, spanning over 1,000 pages, has three main components:<\/p>\n<p><strong><em><b><i>Regulation Best Interest: <\/i><\/b><\/em><\/strong> 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, \u201cRegulation Best Interest.\u201d Although the term \u201cBest Interest\u201d 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:<\/p>\n<p>(1) Disclosure obligation \u2013 a broker-dealer must disclose key facts about its relationship with its customers, including material conflicts of interest.<\/p>\n<p>(2) Care obligation \u2013 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\u2019s best interest.<\/p>\n<p>(3) Conflict of interest obligation \u2013 a broker-dealer must establish, maintain and enforce policies and procedures to identify, disclose and mitigate or eliminate conflicts of interest.<\/p>\n<p><strong><em><b><i>Guidance for Investment Advisers:<\/i><\/b><\/em><\/strong> 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\u2019s proposal seeks to gather, summarize and reaffirm existing guidance in one place.<\/p>\n<p><strong><em><b><i>Form CRS:<\/i><\/b><\/em><\/strong> 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\u2019s ability to identify itself as an \u201cadviser\u201d unless it is registered with the SEC as an investment adviser, so as not to cause confusion among investors.<\/p>\n<p><strong><em><b><i>Takeaways<\/i><\/b><\/em><\/strong><\/p>\n<p>In the wake of the controversy launched by Dodd-Frank and the DOL rule, and on the heels of the Fifth Circuit\u2019s rejection of that rule, the SEC has taken a bold step in the direction of increased regulation of broker-dealers. The SEC\u2019s 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.<\/p>\n<!-- AddThis Advanced Settings generic via filter on the_content --><!-- AddThis Share Buttons generic via filter on the_content -->","protected":false},"excerpt":{"rendered":"<p>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\u2019s proposal is the newest development in an ongoing effort to clearly [&hellip;]<!-- AddThis Advanced Settings generic via filter on get_the_excerpt --><!-- AddThis Share Buttons generic via filter on get_the_excerpt --><\/p>\n","protected":false},"author":759,"featured_media":935,"comment_status":"closed","ping_status":"closed","sticky":false,"template":"","format":"standard","meta":{"footnotes":""},"categories":[46],"tags":[601,1840,1841,1741],"coauthors":[1829,197],"class_list":["post-1684","post","type-post","status-publish","format-standard","has-post-thumbnail","hentry","category-sec","tag-broker-dealer","tag-department-of-labor","tag-dol","tag-jay-clayton"],"_links":{"self":[{"href":"https:\/\/blogs.orrick.com\/securities-litigation\/wp-json\/wp\/v2\/posts\/1684","targetHints":{"allow":["GET"]}}],"collection":[{"href":"https:\/\/blogs.orrick.com\/securities-litigation\/wp-json\/wp\/v2\/posts"}],"about":[{"href":"https:\/\/blogs.orrick.com\/securities-litigation\/wp-json\/wp\/v2\/types\/post"}],"author":[{"embeddable":true,"href":"https:\/\/blogs.orrick.com\/securities-litigation\/wp-json\/wp\/v2\/users\/759"}],"replies":[{"embeddable":true,"href":"https:\/\/blogs.orrick.com\/securities-litigation\/wp-json\/wp\/v2\/comments?post=1684"}],"version-history":[{"count":0,"href":"https:\/\/blogs.orrick.com\/securities-litigation\/wp-json\/wp\/v2\/posts\/1684\/revisions"}],"wp:featuredmedia":[{"embeddable":true,"href":"https:\/\/blogs.orrick.com\/securities-litigation\/wp-json\/wp\/v2\/media\/935"}],"wp:attachment":[{"href":"https:\/\/blogs.orrick.com\/securities-litigation\/wp-json\/wp\/v2\/media?parent=1684"}],"wp:term":[{"taxonomy":"category","embeddable":true,"href":"https:\/\/blogs.orrick.com\/securities-litigation\/wp-json\/wp\/v2\/categories?post=1684"},{"taxonomy":"post_tag","embeddable":true,"href":"https:\/\/blogs.orrick.com\/securities-litigation\/wp-json\/wp\/v2\/tags?post=1684"},{"taxonomy":"author","embeddable":true,"href":"https:\/\/blogs.orrick.com\/securities-litigation\/wp-json\/wp\/v2\/coauthors?post=1684"}],"curies":[{"name":"wp","href":"https:\/\/api.w.org\/{rel}","templated":true}]}},{"id":1679,"date":"2018-03-29T14:42:55","date_gmt":"2018-03-29T18:42:55","guid":{"rendered":"http:\/\/blogs.orrick.com\/securities-litigation\/?p=1679"},"modified":"2020-03-11T17:15:18","modified_gmt":"2020-03-11T21:15:18","slug":"d-c-circuit-holds-pcaob-improperly-denied-target-of-investigation-access-to-expert-assistance","status":"publish","type":"post","link":"https:\/\/blogs.orrick.com\/securities-litigation\/2018\/03\/29\/d-c-circuit-holds-pcaob-improperly-denied-target-of-investigation-access-to-expert-assistance\/","title":{"rendered":"D.C. Circuit Holds PCAOB Improperly Denied Target of Investigation Access to Expert Assistance"},"content":{"rendered":"<p>A D.C. Circuit panel unanimously ruled that the Public Company Accounting Oversight Board (&#8220;PCAOB&#8221;) acted unlawfully by denying former Ernst &amp; Young partner Marc Laccetti his right to bring an accounting expert to an investigative interview. The March 23rd decision in <a href=\"https:\/\/www.cadc.uscourts.gov\/internet\/opinions.nsf\/56F33A79D5CF078C85258259004D4D87\/$file\/16-1368.pdf\">Laccetti v. Securities &amp; Exchange Commission<\/a> potentially throws the validity of many pending PCAOB investigations into question and provides important procedural rights to the subjects of those investigations.<\/p>\n<p>Laccetti was investigated and sanctioned by the PCAOB in connection with Ernst &amp; Young&#8217;s audit of Taro Pharmaceutical Industries, Ltd.&#8217;s 2004 financial statements. The PCAOB&#8217;s rules provide witnesses interviewed by the PCAOB the right to be represented by counsel. However, the PCAOB had interpreted that rule as limited to lawyers only. Accordingly, when Laccetti was interviewed during the PCAOB&#8217;s investigation, the PCAOB permitted Lacetti to be accompanied by an in-house Ernst &amp; Young lawyer but refused his request that an Ernst &amp; Young accounting expert also be present. The PCAOB advised Laccetti that he and his counsel could consult with an expert before or after testifying, but that the presence of any technical expert was &#8220;not appropriate&#8221; at the interview. Following that interview, in a decision subsequently affirmed by the Securities and Exchange Commission (&#8220;SEC&#8221;), the PCAOB fined Laccetti $85,000 and suspended him from the accounting profession for two years.<!--more--><\/p>\n<p>On appeal, Laccetti argued that the PCAOB&#8217;s decision to bar the accounting expert from the interview was unreasonable and that it violated his right to counsel. The sole reason the PCAOB provided for denying Laccetti&#8217;s request was that it did not want Ernst &amp; Young personnel present during the interview to monitor the investigation. The D.C. Circuit rejected this argument as unreasonable on its face. After all, the PCAOB expressly permitted a lawyer from Ernst &amp; Young&#8217;s in-house legal team to attend the interview. And the PCAOB&#8217;s stated desire to prevent an Ernst &amp; Young employee from monitoring the interview could not be squared with the fact that it refused to let Laccetti bring any accounting expert at all. The court also held that the right to counsel provided by the PCAOB&#8217;s rules encompasses the right to have an expert assist a legal representative during an investigative interview. The court noted that the ability to have expert assistance as part of the right to counsel had long been available under SEC proceedings and other proceedings governed by the Administrative Procedure Act. Nothing in the PCAOB&#8217;s rules suggested that the right to counsel they provided should be any narrower than the rights afforded under the APA. However, the court expressly left open the possibility that the PCAOB could amend its rules to bring about a different result, subject to statutory and constitutional limitations. The court reversed the underlying order and sanctions, rejecting the PCAOB&#8217;s argument that any error in denying the right to counsel was harmless, but did not foreclose the PCAOB from reopening a new enforcement action against Laccetti.<\/p>\n<p>Although the court claimed its holding was an &#8220;exceedingly narrow&#8221; one, it provides important protections to individuals subject to PCAOB investigations, confirming that they have a right to be accompanied by counsel including an accounting expert of their choosing. The decision also enhances the ability of accounting firms to assist individuals who become targets of investigations. And the decision suggests that any pending proceeding in which the PCAOB denied a witness the right to expert assistance will, at the very least, need to have new testimony taken with adequate assistance available. The number of investigative matters affected could be substantial.<\/p>\n<p>The procedural background of the Laccetti case also illustrates the practical difficulties that arise when administrative agencies violate the rights of individuals they investigate. The investigative interview of Laccetti took place in 2007 and the applicable procedural rules meant that Laccetti was forced to receive a PCAOB sanction and pursue an administrative appeal to the SEC before he could finally obtain judicial review. The great majority of PCAOB respondents who are threatened with charges settle their proceedings. Indeed, in the eleven years Laccetti&#8217;s matter has been pending, scores of PCAOB respondents have agreed to accept sanctions rather than take their cases to trial and through the multi-level appeals process. Many of these individuals likely were denied expert assistance during investigative interviews just like Laccetti, but lacked the resources to pursue the years-long legal process necessary to vindicate their rights.<\/p>\n<!-- AddThis Advanced Settings generic via filter on the_content --><!-- AddThis Share Buttons generic via filter on the_content -->","protected":false},"excerpt":{"rendered":"<p>A D.C. Circuit panel unanimously ruled that the Public Company Accounting Oversight Board (&#8220;PCAOB&#8221;) acted unlawfully by denying former Ernst &amp; Young partner Marc Laccetti his right to bring an accounting expert to an investigative interview. The March 23rd decision in Laccetti v. Securities &amp; Exchange Commission potentially throws the validity of many pending PCAOB [&hellip;]<!-- AddThis Advanced Settings generic via filter on get_the_excerpt --><!-- AddThis Share Buttons generic via filter on get_the_excerpt --><\/p>\n","protected":false},"author":49,"featured_media":1111,"comment_status":"closed","ping_status":"closed","sticky":false,"template":"","format":"standard","meta":{"footnotes":""},"categories":[764,224,46],"tags":[1851,1850,534],"coauthors":[185,1845,1846],"class_list":["post-1679","post","type-post","status-publish","format-standard","has-post-thumbnail","hentry","category-client-alert","category-pcaob","category-sec","tag-laccetti","tag-laccetti-v-securities-exchange-commission","tag-securities-and-exchange-commission"],"_links":{"self":[{"href":"https:\/\/blogs.orrick.com\/securities-litigation\/wp-json\/wp\/v2\/posts\/1679","targetHints":{"allow":["GET"]}}],"collection":[{"href":"https:\/\/blogs.orrick.com\/securities-litigation\/wp-json\/wp\/v2\/posts"}],"about":[{"href":"https:\/\/blogs.orrick.com\/securities-litigation\/wp-json\/wp\/v2\/types\/post"}],"author":[{"embeddable":true,"href":"https:\/\/blogs.orrick.com\/securities-litigation\/wp-json\/wp\/v2\/users\/49"}],"replies":[{"embeddable":true,"href":"https:\/\/blogs.orrick.com\/securities-litigation\/wp-json\/wp\/v2\/comments?post=1679"}],"version-history":[{"count":0,"href":"https:\/\/blogs.orrick.com\/securities-litigation\/wp-json\/wp\/v2\/posts\/1679\/revisions"}],"wp:featuredmedia":[{"embeddable":true,"href":"https:\/\/blogs.orrick.com\/securities-litigation\/wp-json\/wp\/v2\/media\/1111"}],"wp:attachment":[{"href":"https:\/\/blogs.orrick.com\/securities-litigation\/wp-json\/wp\/v2\/media?parent=1679"}],"wp:term":[{"taxonomy":"category","embeddable":true,"href":"https:\/\/blogs.orrick.com\/securities-litigation\/wp-json\/wp\/v2\/categories?post=1679"},{"taxonomy":"post_tag","embeddable":true,"href":"https:\/\/blogs.orrick.com\/securities-litigation\/wp-json\/wp\/v2\/tags?post=1679"},{"taxonomy":"author","embeddable":true,"href":"https:\/\/blogs.orrick.com\/securities-litigation\/wp-json\/wp\/v2\/coauthors?post=1679"}],"curies":[{"name":"wp","href":"https:\/\/api.w.org\/{rel}","templated":true}]}},{"id":1669,"date":"2018-03-23T12:47:03","date_gmt":"2018-03-23T16:47:03","guid":{"rendered":"http:\/\/blogs.orrick.com\/securities-litigation\/?p=1669"},"modified":"2018-03-23T19:37:05","modified_gmt":"2018-03-23T23:37:05","slug":"fifth-circuit-vacates-department-of-labors-fiduciary-rule","status":"publish","type":"post","link":"https:\/\/blogs.orrick.com\/securities-litigation\/2018\/03\/23\/fifth-circuit-vacates-department-of-labors-fiduciary-rule\/","title":{"rendered":"Fifth Circuit Vacates Department of Labor\u2019s Fiduciary Rule"},"content":{"rendered":"<p>Last week, a divided panel of the U.S. Court of Appeals for the Fifth Circuit struck down the U.S. Department of Labor\u2019s (\u201cDOL\u201d) \u201cFiduciary Rule,\u201d a controversial measure that redefined exemptions to Employee Retirement Income Security Act of 1974 (\u201cERISA\u201d) provisions concerning fiduciaries. The DOL\u2019s 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 \u201cinvestment advice fiduciary,\u201d heightening the fiduciary duty for these financial professionals to a \u201cbest interest\u201d standard for their clients with ERISA plans and individual retirement accounts (\u201cIRAs\u201d). This \u201cbest interest\u201d standard marked a significant departure from the prior standard for brokers, which required them to recommend investments that were merely \u201csuitable\u201d for their clients. Second, the Fiduciary Rule created a \u201cBest Interest Contract Exemption,\u201d which allowed financial professionals to avoid prohibited transactions penalties as long as they contractually affirmed their fiduciary status.<!--more--><\/p>\n<p><strong><b>Background Behind the Fiduciary Rule<\/b><\/strong><\/p>\n<p>The tense political arena surrounding the DOL\u2019s rule began well-before the rule\u2019s debut. In 2010, Dodd-Frank, the Obama-era financial reform law, delegated authority to the Securities and Exchange Commission (\u201cSEC\u201d) to propose a uniform fiduciary rule for retail investment accounts. Rather than waiting for the SEC\u2019s rule, the DOL took it upon itself to promulgate its own Fiduciary Rule in 2016. According to his statements, SEC Chairman Jay Clayton has been working with the DOL since his appointment in May 2017 to find common ground on a fiduciary standard that would apply to investment accounts across the board. And Chairman Clayton stated that the SEC will continue to move forward with its rule in the wake of the Fifth Circuit\u2019s rejection of the DOL\u2019s rule. Without going into specifics, he told attendees at the recent SIFMA Compliance and Law Conference that he was hoping to propose a new simplified standard of disclosure for broker-dealers and investment advisers related to individual clients as well as those saving for retirement.<\/p>\n<p><strong><b>Fifth Circuit\u2019s Decision<\/b><\/strong><\/p>\n<p>The Fifth Circuit\u2019s decision striking down the DOL\u2019s Fiduciary Rule in <em><i>Chamber of Commerce v. U.S. Department of Labor<\/i><\/em> represents a major victory for industry participants. Judge Edith Jones, writing for the panel majority, held that the DOL acted arbitrarily and capriciously in enacting its Fiduciary Rule and improperly went beyond the scope of its delegated administrative authority. The panel enumerated seven reasons why the rule was unreasonable, and noted that the rule \u201cinfring[ed] on SEC turf.\u201d The \u201cDOL,\u201d Jones stated, \u201chas made no secret of its intent to transform the trillion-dollar market for IRA investments, annuities and insurance products, and to regulate in a new way the thousands of people and organizations working in that market.\u201d Specifically, the court determined that the Fiduciary Rule\u2019s new definition of \u201cfiduciary\u201d was inconsistent with the text of ERISA and the Internal Revenue Code and inconsistent with the common-law meaning of \u201cfiduciary,\u201d and that the DOL impermissibly abused its authority to grant the exemptions from regulatory burdens, including the Best Interest Contract Exemption. The court thus vacated the DOL\u2019s Fiduciary Rule under the Administrative Procedure Act, effectively voiding the entire rule nationwide.<\/p>\n<p><strong><b>What\u2019s Next?<\/b><\/strong><\/p>\n<p>At the time of the Fifth Circuit decision, the DOL\u2019s Fiduciary Rule was already on the ropes; the DOL has delayed full implementation of the rule until July 2019 to complete a review into the rule\u2019s full scope. The DOL may have lost the battle in the Fifth Circuit, but the war is not over. There remains a chance that these complex fiduciary questions will find their way to the U.S. Supreme Court. Just days before the Fifth Circuit\u2019s decision, the Tenth Circuit ruled in favor of the DOL on a more limited challenge to the Fiduciary Rule. This partial split between federal circuits makes this issue potentially ripe for Supreme Court review. Separately, the SEC began conducting a review of the Fiduciary Rule in October 2017, with a goal of introducing a new rule that harmonizes regulation of investment advice. An SEC rule likely would apply to a broader swath of brokers \u2013 not just those who sell retirement products \u2013 and could dramatically change the investment community\u2019s practices.<\/p>\n<!-- AddThis Advanced Settings generic via filter on the_content --><!-- AddThis Share Buttons generic via filter on the_content -->","protected":false},"excerpt":{"rendered":"<p>Last week, a divided panel of the U.S. Court of Appeals for the Fifth Circuit struck down the U.S. Department of Labor\u2019s (\u201cDOL\u201d) \u201cFiduciary Rule,\u201d a controversial measure that redefined exemptions to Employee Retirement Income Security Act of 1974 (\u201cERISA\u201d) provisions concerning fiduciaries. The DOL\u2019s rule, promulgated in April 2016, consisted of a package of [&hellip;]<!-- AddThis Advanced Settings generic via filter on get_the_excerpt --><!-- AddThis Share Buttons generic via filter on get_the_excerpt --><\/p>\n","protected":false},"author":759,"featured_media":1674,"comment_status":"closed","ping_status":"closed","sticky":false,"template":"","format":"standard","meta":{"footnotes":""},"categories":[258],"tags":[1260,1844,1840,1841,1842,1752,325,1407],"coauthors":[1829,1578,1843],"class_list":["post-1669","post","type-post","status-publish","format-standard","has-post-thumbnail","hentry","category-dodd-frank-act-2","tag-chamber-of-commerce","tag-chamber-of-commerce-v-u-s-department-of-labor","tag-department-of-labor","tag-dol","tag-erisa","tag-fiduciary-rule","tag-fifth-circuit","tag-u-s-court-of-appeals"],"_links":{"self":[{"href":"https:\/\/blogs.orrick.com\/securities-litigation\/wp-json\/wp\/v2\/posts\/1669","targetHints":{"allow":["GET"]}}],"collection":[{"href":"https:\/\/blogs.orrick.com\/securities-litigation\/wp-json\/wp\/v2\/posts"}],"about":[{"href":"https:\/\/blogs.orrick.com\/securities-litigation\/wp-json\/wp\/v2\/types\/post"}],"author":[{"embeddable":true,"href":"https:\/\/blogs.orrick.com\/securities-litigation\/wp-json\/wp\/v2\/users\/759"}],"replies":[{"embeddable":true,"href":"https:\/\/blogs.orrick.com\/securities-litigation\/wp-json\/wp\/v2\/comments?post=1669"}],"version-history":[{"count":0,"href":"https:\/\/blogs.orrick.com\/securities-litigation\/wp-json\/wp\/v2\/posts\/1669\/revisions"}],"wp:featuredmedia":[{"embeddable":true,"href":"https:\/\/blogs.orrick.com\/securities-litigation\/wp-json\/wp\/v2\/media\/1674"}],"wp:attachment":[{"href":"https:\/\/blogs.orrick.com\/securities-litigation\/wp-json\/wp\/v2\/media?parent=1669"}],"wp:term":[{"taxonomy":"category","embeddable":true,"href":"https:\/\/blogs.orrick.com\/securities-litigation\/wp-json\/wp\/v2\/categories?post=1669"},{"taxonomy":"post_tag","embeddable":true,"href":"https:\/\/blogs.orrick.com\/securities-litigation\/wp-json\/wp\/v2\/tags?post=1669"},{"taxonomy":"author","embeddable":true,"href":"https:\/\/blogs.orrick.com\/securities-litigation\/wp-json\/wp\/v2\/coauthors?post=1669"}],"curies":[{"name":"wp","href":"https:\/\/api.w.org\/{rel}","templated":true}]}},{"id":1663,"date":"2018-02-28T13:00:29","date_gmt":"2018-02-28T18:00:29","guid":{"rendered":"http:\/\/blogs.orrick.com\/securities-litigation\/?p=1663"},"modified":"2021-04-12T12:26:32","modified_gmt":"2021-04-12T16:26:32","slug":"looking-out-for-main-street-sec-focuses-on-retail-cybersecurity-and-cryptocurrency","status":"publish","type":"post","link":"https:\/\/blogs.orrick.com\/securities-litigation\/2018\/02\/28\/looking-out-for-main-street-sec-focuses-on-retail-cybersecurity-and-cryptocurrency\/","title":{"rendered":"Looking Out for Main Street: SEC Focuses on Retail, Cybersecurity and Cryptocurrency"},"content":{"rendered":"<p>The Commissioners and senior officials of the Securities and Exchange Commission (\u201cSEC\u201d or \u201cCommission\u201d) addressed the public on February 23-24 at the annual \u201cSEC Speaks\u201d 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\u2019s 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.<\/p>\n<p>Following are the key litigation and enforcement takeaways.<\/p>\n<p><strong><b>Main Street Investors<\/b><\/strong><\/p>\n<p>Commissioner Kara Stein picked up on Clayton\u2019s 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 <em><i>could<\/i><\/em> develop and sell these products, but whether it <em><i>should<\/i><\/em>. 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\u2019 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.<\/p>\n<p>Steven Peikin, Co-Director of the Division of Enforcement, described the SEC\u2019s 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\u2019s Broker-Dealer Task Force shared that AML programs and SAR-filing obligations are also a priority for the Enforcement division and OCIE exams.<!--more--><\/p>\n<p><strong><b>Cybersecurity<\/b><\/strong><\/p>\n<p>The Corporate Finance panel addressed the Commission\u2019s recently published interpretive guidance to assist public companies in preparing disclosures about cybersecurity risks and incidents. The panel suggested that in order to generate timely disclosures of cybersecurity incidents, corporate controls and policies should require significant issues to be escalated up the corporate chain. Companies need to be thoughtful in how they accomplish this, and a process that only includes the IT department or is done on an ad hoc basis is not sufficient. These disclosures should not be static, and even if there are ongoing internal or external investigations about the incident, the company needs to inform the market when issues become known.<\/p>\n<p>The Corporate Finance panel also encouraged companies to develop thoughtful insider trading policies that incorporate cyber events that might be considered material events that affect the ability of insiders to trade. If the company is trying to decide whether it has a material issue, any insider who is presumed to know the information should take a hiatus on trading. The panel added that these policies could be prophylactic, similar to what companies have in place to prevent trading at the end of a quarter.<\/p>\n<p>The Enforcement division formed a new Cyber Unit in the fall of 2017 to deal with these types of risks, among others. The unit includes thirty people in five different offices. The Enforcement panel made clear that firms regulated by the SEC should have cybersecurity controls and that those controls should be publicly disclosed.<\/p>\n<p><strong><b>Cryptocurrency and Blockchain<\/b><\/strong><\/p>\n<p>As expected, recent developments in cryptocurrency and blockchain are top concerns for the SEC. The Corporate Finance and Enforcement divisions are working together to enforce securities laws against companies that seem to be deliberately trying to avoid them. Speakers explained that when the SEC staff review a hybrid token to determine if it is a security, they look at the economic substance of what is being offered to investors and also review the relevant marketing materials. The SEC believes that the factors described in <em><i>Howey <\/i><\/em>are key to answering this question. If the token at issue includes a financial interest in a company, the SEC will consider it a security. The Enforcement panel emphasized that merely calling something a \u201ctoken\u201d is not sufficient to take it outside the scope of the federal securities laws. The Commission made clear it had high expectations of gatekeepers, especially lawyers, in this process and expected them to be thoughtful in recognizing when they were dealing with a security and not try to circumvent the issue with clever terminology. The Enforcement panel expressed disappointment that some \u201cgenuine law firms\u201d had disingenuously opined that certain tokens were not securities, and that they expected more from the gatekeeper community.<\/p>\n<p>Rob Cohen, Chief of the SEC\u2019s recently formed Cyber Unit, told the audience that there are two types of Initial Coin Offering (\u201cICO\u201d) cases in which the SEC is interested. The first is garden variety fraud in which a company puts \u201cblockchain\u201d or \u201ccrypto\u201d in its name, allegedly changes the nature of its business, and then the stock price skyrockets. The second is more subtle and involves investigating ICOs to see whether there were material misrepresentations or registration concerns. Cohen stressed that ICOs need to be either registered or genuinely qualify for a registration exemption. Cohen said that in the last year at least a dozen ICOs had been voluntarily put on hold after the companies received a call from the SEC asking the companies to look more closely at certain legal issues. Cohen believed that since the market was now on notice, he expected the Commission to use more stringent remedies going forward.<\/p>\n<p><strong><b>Effective Client Advocacy<\/b><\/strong><\/p>\n<p>The Enforcement panel warned counsel not to engage in a broad discussion of scheme liability under the antifraud provisions of the federal securities laws (Rule 10b-5 or Securities Act \u00a7 17(a)) in white papers or Wells notices. The SEC explained that this line of argument was neither helpful to the SEC nor effective for counsel, since it painted the issue with too broad a brush as those provisions do not always require the SEC to prove a scheme. The panel pointed to <em><i>Lorenzo v. SEC <\/i><\/em>in the D.C. Circuit as a good analysis of the issue. In this case, Lorenzo allegedly knowingly sent misleading emails to investors that included misstatements copied and pasted from emails written by Lorenzo\u2019s boss. While the D.C. Circuit agreed with the defendant that he could not be found liable under Rule 10b-5(b) as the <em><i>maker<\/i><\/em> of false and misleading statements, he had nevertheless perpetrated a fraud in violation of the securities laws by including these statements in his emails. While the SEC recognized that decisions in other circuits may be read to require the SEC to prove conduct beyond misstatements, the SEC said counsel should consider whether this actually allows their clients to avoid the broad spectrum of conduct that falls under the antifraud provisions. The panel added that the SEC typically prevails on motions to dismiss, even in circuits where the case law initially appears more favorable to the defense.<\/p>\n<p>With respect to cooperation credit, the Enforcement panel emphasized that a company needs to do more than respond to subpoenas on time and bring in witnesses for interviews and testimony. Rather, companies and individuals need to take affirmative action to allow the staff to reach a resolution, either in a shorter period of time or by using fewer resources. It would also constitute cooperation if a company returned money to investors or enhanced its controls and policies. The panel cited the SEC settlement <em><i>In re Munchee, Inc.<\/i><\/em> as a good example of the type of cooperation that the Commission finds helpful.<\/p>\n<p><strong><b>High Profile Litigation<\/b><\/strong><\/p>\n<p>The Enforcement panel also discussed some of its recent high profile cases. It cautioned that last year\u2019s Supreme Court decision in <em><i>Kokesh v. SEC<\/i><\/em>, which found that any claim for disgorgement in an SEC enforcement action was a penalty to which a five-year statute of limitations applies, was a limited ruling and that courts had not been applying the decision to remedies other than disgorgement, such as injunctions. <em><i>Kokesh<\/i><\/em>, however, has affected the investigative process, in that the SEC is trying to reduce the time taken to complete an investigation and to be more judicious about its use of tolling agreements. The Commission said it is also no longer routinely tacking a tolling agreement onto every case when it serves a subpoena. Moreover, in cases where conduct has aged by the time the SEC learns of it, it may elect not to open an investigation.<\/p>\n<p>The SEC addressed the constitutional challenges to its use of administrative proceedings, and confirmed that since the Supreme Court granted <em><i>certiorari<\/i><\/em> on this issue, the number of contested administrative hearings it is bringing has decreased. In a significant revelation, the Commission informed the group that it is now bringing administrative proceedings exclusively when the primary remedy is available only in the administrative forum, such as failure to supervise cases or cases involving a 102(e) bar for people who practice before the Commission.<\/p>\n<p>The Appellate Division said (citing its Supreme Court amicus brief in <em><i>Leidos, Inc. v. Indiana Public Retirement System<\/i><\/em>) that despite the clear language in <em><i>Basic, Inc. v. Levinson<\/i><\/em>, companies cannot stay silent, and have a duty to disclose material nonpublic information under Item 303 and virtually all the SEC\u2019s other reporting regulations.<\/p>\n<!-- AddThis Advanced Settings generic via filter on the_content --><!-- AddThis Share Buttons generic via filter on the_content -->","protected":false},"excerpt":{"rendered":"<p>The Commissioners and senior officials of the Securities and Exchange Commission (\u201cSEC\u201d or \u201cCommission\u201d) addressed the public on February 23-24 at the annual \u201cSEC Speaks\u201d 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. [&hellip;]<!-- AddThis Advanced Settings generic via filter on get_the_excerpt --><!-- AddThis Share Buttons generic via filter on get_the_excerpt --><\/p>\n","protected":false},"author":759,"featured_media":1200,"comment_status":"closed","ping_status":"closed","sticky":false,"template":"","format":"standard","meta":{"footnotes":""},"categories":[764,371,46],"tags":[1447,1832,154,1741,1092,1750,1838,1837,1087,239],"coauthors":[1829,1578],"class_list":["post-1663","post","type-post","status-publish","format-standard","has-post-thumbnail","hentry","category-client-alert","category-cybersecurity","category-sec","tag-blockchain","tag-cryptocurrency","tag-finra","tag-jay-clayton","tag-kara-stein","tag-kokesh","tag-leidos","tag-retail","tag-sec-speaks","tag-securities-exchange-commission"],"_links":{"self":[{"href":"https:\/\/blogs.orrick.com\/securities-litigation\/wp-json\/wp\/v2\/posts\/1663","targetHints":{"allow":["GET"]}}],"collection":[{"href":"https:\/\/blogs.orrick.com\/securities-litigation\/wp-json\/wp\/v2\/posts"}],"about":[{"href":"https:\/\/blogs.orrick.com\/securities-litigation\/wp-json\/wp\/v2\/types\/post"}],"author":[{"embeddable":true,"href":"https:\/\/blogs.orrick.com\/securities-litigation\/wp-json\/wp\/v2\/users\/759"}],"replies":[{"embeddable":true,"href":"https:\/\/blogs.orrick.com\/securities-litigation\/wp-json\/wp\/v2\/comments?post=1663"}],"version-history":[{"count":0,"href":"https:\/\/blogs.orrick.com\/securities-litigation\/wp-json\/wp\/v2\/posts\/1663\/revisions"}],"wp:featuredmedia":[{"embeddable":true,"href":"https:\/\/blogs.orrick.com\/securities-litigation\/wp-json\/wp\/v2\/media\/1200"}],"wp:attachment":[{"href":"https:\/\/blogs.orrick.com\/securities-litigation\/wp-json\/wp\/v2\/media?parent=1663"}],"wp:term":[{"taxonomy":"category","embeddable":true,"href":"https:\/\/blogs.orrick.com\/securities-litigation\/wp-json\/wp\/v2\/categories?post=1663"},{"taxonomy":"post_tag","embeddable":true,"href":"https:\/\/blogs.orrick.com\/securities-litigation\/wp-json\/wp\/v2\/tags?post=1663"},{"taxonomy":"author","embeddable":true,"href":"https:\/\/blogs.orrick.com\/securities-litigation\/wp-json\/wp\/v2\/coauthors?post=1663"}],"curies":[{"name":"wp","href":"https:\/\/api.w.org\/{rel}","templated":true}]}},{"id":1660,"date":"2018-02-16T13:53:05","date_gmt":"2018-02-16T18:53:05","guid":{"rendered":"http:\/\/blogs.orrick.com\/securities-litigation\/?p=1660"},"modified":"2018-02-16T13:53:05","modified_gmt":"2018-02-16T18:53:05","slug":"finra-enforcement-head-explains-why-enforcement-isnt-rocket-science","status":"publish","type":"post","link":"https:\/\/blogs.orrick.com\/securities-litigation\/2018\/02\/16\/finra-enforcement-head-explains-why-enforcement-isnt-rocket-science\/","title":{"rendered":"FINRA Enforcement Head Explains Why Enforcement \u201cIsn\u2019t Rocket Science\u201d"},"content":{"rendered":"<p>In a <a href=\"http:\/\/www.finra.org\/newsroom\/speeches\/021218-remarks-sifma-aml?utm_source=MM&amp;utm_medium=email&amp;utm_campaign=Weekly%5FUpdate%5F021418%5FFINAL\">speech at the SIFMA AML Conference last week<\/a>, FINRA Head of Enforcement Susan Schroeder openly explained the \u201cstraightforward framework\u201d that Enforcement uses when making decisions about enforcement actions. The context for Schroeder\u2019s speech was FINRA\u2019s merger of two separate enforcement departments, resulting from FINRA head Robert Cook\u2019s \u201clistening tour\u201d and FINRA\u2019s recent self-evaluation, but Schroeder\u2019s explanation appeared to be more of a response to broader industry complaints about FINRA Enforcement\u2019s lack of consistency and transparency in its charging and sanctions decisions.<\/p>\n<p>If that was Schroeder\u2019s mission, she was successful. She identified the goals of enforcement actions, and justified FINRA\u2019s use of its enforcement tool based upon harms to investors and perceived market risks. Overarching Schroeder\u2019s speech was the principle that firms should know \u201cwhat to expect from their regulator\u201d so they know \u201chow to shape their behavior in order to comply with the rules.\u201d 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\u2019s enforcement activities.<\/p>\n<p>Here are the principles in Schroeder\u2019s own words:<\/p>\n<p><strong>Is this enforcement action appropriate? <\/strong>According to Schroeder, enforcement actions should be brought to \u201cfix something that is broken or to prevent future misconduct, either by the same respondent or by another individual or firm.\u201d Enforcement is not the only means FINRA has to fix something, and it is not always the \u201cright tool\u201d to use. To determine whether enforcement action is the appropriate regulatory response, FINRA will ask:<!--more--><\/p>\n<ul>\n<li><b><strong>Is there demonstrated financial harm resulting from the misconduct? <\/strong><\/b>If this is the case, FINRA expects the \u201cfirm or the individual who caused that harm\u201d to \u201cmake the customers whole.<\/li>\n<li><b><strong>Has there been a significant impact to market integrity? <\/strong><\/b>If so, FINRA will ensure that the \u201cissue is fixed\u201d and that steps are taken \u201cto prevent something harmful from recurring.\u201d<\/li>\n<li><b><strong>Did the misconduct create significant risk? <\/strong><\/b>Schroeder recognized that this is where \u201cmost [] cases land.\u201d In these instances, FINRA analyzes \u201cwhether the misconduct created significant risk, such that the misconduct requires an enforcement response in order to prevent and deter future harm.\u201d In particular, FINRA focuses on cases where there is (1) \u201chigh likelihood of harm,\u201d (2) \u201cpotential for widespread harm,\u201d or (3) \u201cintentional or reckless misconduct.\u201d According to Schroeder, the following activities constitute \u201cred flags\u201d: \u201crepeated misconduct after disciplinary action,\u201d \u201cbroad patterns of disregarding regulatory requirements,\u201d and \u201cfailure to implement reasonable supervision.\u201d<\/li>\n<\/ul>\n<p><strong>What does a fair and effective sanction look like? <\/strong>FINRA has a host of sanctions options available to it \u2013 \u201cfines, restitution, disgorgement, expulsions, bars, plenary and principle suspensions, undertakings, rescission, requirements to requalify, business restrictions, supervision requirements, and pre-approval requirements\u201d \u2013 but when is it appropriate to use which ones? FINRA\u2019s \u201chighest priority\u201d is to \u201cobtain restitution for harmed investors.\u201d But Schroeder recognizes that \u201cthere are many cases in which that is not practical because there has been no calculable financial harm.\u201d In those instances, FINRA seeks to \u201ctailor sanctions to most effectively address the root of the problem.\u201d When determining sanctions, FINRA asks:<\/p>\n<ul>\n<li><strong>Have wronged investors been made whole?<\/strong> If investors have been harmed, this is \u201cthe most important outcome\u201d of sanctions.<\/li>\n<li><strong>Do sanctions effectively address the root of the problem? <\/strong>Schroeder admits that this is \u201cone of the hardest parts of [FINRA\u2019s] job.\u201d According to Schroeder, sanctions should: (1) be \u201cproportionate to the harm or risk of harm posed,\u201d (2) \u201cencourage remediation\u201d (but \u201cnot be excessive to the point of being vindictive\u201d), and (3) \u201creflect credit for cooperation and discipline by other regulators.\u201d<\/li>\n<\/ul>\n<p>For its part, FINRA\u2019s merged Enforcement Department will approach cases consistently and \u201creach foreseeable conclusions,\u201d according to Schroeder. Schroeder promised \u201cthoughtful, balanced, and timely [FINRA] investigations.\u201d In particular, Schroeder said that settlement documents \u2013 she cited the AML context as an example \u2013 should identify the \u201clegal framework supporting [FINRA\u2019s] conclusions,\u201d so that anyone looking at a case can \u201cimmediately understand the basis for the charge.\u201d<\/p>\n<p>Schroeder\u2019s speech offers helpful guidance to firms seeking to focus their compliance priorities or understand why FINRA has brought enforcement action or sanctions against them. Schroeder also appears to accept, on behalf of FINRA, responsibility for ensuring that firms understand exactly what FINRA expects and why FINRA believes certain enforcement actions and sanctions are deserved. Firms and counsel who deal with FINRA in enforcement matters should hold the regulator to these principles. In short, firms now have a template for engaging more constructively with FINRA Enforcement.<\/p>\n<!-- AddThis Advanced Settings generic via filter on the_content --><!-- AddThis Share Buttons generic via filter on the_content -->","protected":false},"excerpt":{"rendered":"<p>In a speech at the SIFMA AML Conference last week, FINRA Head of Enforcement Susan Schroeder openly explained the \u201cstraightforward framework\u201d that Enforcement uses when making decisions about enforcement actions. The context for Schroeder\u2019s speech was FINRA\u2019s merger of two separate enforcement departments, resulting from FINRA head Robert Cook\u2019s \u201clistening tour\u201d and FINRA\u2019s recent self-evaluation, [&hellip;]<!-- AddThis Advanced Settings generic via filter on get_the_excerpt --><!-- AddThis Share Buttons generic via filter on get_the_excerpt --><\/p>\n","protected":false},"author":759,"featured_media":1124,"comment_status":"closed","ping_status":"closed","sticky":false,"template":"","format":"standard","meta":{"footnotes":""},"categories":[496],"tags":[1207,1206,290,154,1638,1836],"coauthors":[1829,1833],"class_list":["post-1660","post","type-post","status-publish","format-standard","has-post-thumbnail","hentry","category-financial-institutions","tag-aml","tag-anti-money-laundering","tag-enforcement","tag-finra","tag-sifma","tag-susan-schroeder"],"_links":{"self":[{"href":"https:\/\/blogs.orrick.com\/securities-litigation\/wp-json\/wp\/v2\/posts\/1660","targetHints":{"allow":["GET"]}}],"collection":[{"href":"https:\/\/blogs.orrick.com\/securities-litigation\/wp-json\/wp\/v2\/posts"}],"about":[{"href":"https:\/\/blogs.orrick.com\/securities-litigation\/wp-json\/wp\/v2\/types\/post"}],"author":[{"embeddable":true,"href":"https:\/\/blogs.orrick.com\/securities-litigation\/wp-json\/wp\/v2\/users\/759"}],"replies":[{"embeddable":true,"href":"https:\/\/blogs.orrick.com\/securities-litigation\/wp-json\/wp\/v2\/comments?post=1660"}],"version-history":[{"count":0,"href":"https:\/\/blogs.orrick.com\/securities-litigation\/wp-json\/wp\/v2\/posts\/1660\/revisions"}],"wp:featuredmedia":[{"embeddable":true,"href":"https:\/\/blogs.orrick.com\/securities-litigation\/wp-json\/wp\/v2\/media\/1124"}],"wp:attachment":[{"href":"https:\/\/blogs.orrick.com\/securities-litigation\/wp-json\/wp\/v2\/media?parent=1660"}],"wp:term":[{"taxonomy":"category","embeddable":true,"href":"https:\/\/blogs.orrick.com\/securities-litigation\/wp-json\/wp\/v2\/categories?post=1660"},{"taxonomy":"post_tag","embeddable":true,"href":"https:\/\/blogs.orrick.com\/securities-litigation\/wp-json\/wp\/v2\/tags?post=1660"},{"taxonomy":"author","embeddable":true,"href":"https:\/\/blogs.orrick.com\/securities-litigation\/wp-json\/wp\/v2\/coauthors?post=1660"}],"curies":[{"name":"wp","href":"https:\/\/api.w.org\/{rel}","templated":true}]}},{"id":1657,"date":"2018-02-12T09:54:34","date_gmt":"2018-02-12T14:54:34","guid":{"rendered":"http:\/\/blogs.orrick.com\/securities-litigation\/?p=1657"},"modified":"2021-04-12T12:26:39","modified_gmt":"2021-04-12T16:26:39","slug":"secs-ocie-announces-2018-areas-of-focus","status":"publish","type":"post","link":"https:\/\/blogs.orrick.com\/securities-litigation\/2018\/02\/12\/secs-ocie-announces-2018-areas-of-focus\/","title":{"rendered":"SEC\u2019s OCIE Announces 2018 Areas of Focus"},"content":{"rendered":"<p>On February 7, 2018 the SEC\u2019s Office of Compliance Inspections and Examinations (OCIE) announced its <a href=\"https:\/\/www.sec.gov\/about\/offices\/ocie\/national-examination-program-priorities-2018.pdf\">2018 National Exam Priorities<\/a>. The priorities, formulated with input from the Chairman, Commissioners, SEC Staff and fellow regulators, are mostly unchanged from years past (<a href=\"https:\/\/blogs.orrick.com\/securities-litigation\/2017\/01\/17\/new-year-similar-priorities-sec-announces-2017-ocie-areas-of-focus\/\">New Year, Similar Priorities: SEC Announces 2017 OCIE Areas of Focus, Orrick.com<\/a><a href=\"https:\/\/blogs.orrick.com\/securities-litigation\/2017\/01\/17\/new-year-similar-priorities-sec-announces-2017-ocie-areas-of-focus\/)\">)<\/a>. However, the publication itself is presented in a more formal wrapper that begins with a lengthy message from OCIE\u2019s leadership team describing the Office\u2019s role and guiding principles, including that they are risk-based, data-driven and transparent, and that they embrace innovation and new technology.<\/p>\n<p><strong><b>2018 Priorities<\/b><\/strong><\/p>\n<p>OCIE\u2019s 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 \u2013 sometimes known as \u201crobo-advisors\u201d; 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.<\/p>\n<p>Noting that the cryptocurrency and initial coin offering (ICO) markets \u201cpresent a number of risks for retail investors,\u201d 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.<\/p>\n<p>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\u2019s oversight.<!--more--><\/p>\n<p><strong><b>Insights Regarding Execution of OCIE Priorities <\/b><\/strong><u><b><\/b><\/u><\/p>\n<p>Kristin Snyder, OCIE\u2019s Co-head of the SEC\u2019s Investment Adviser\/Investment Company Examination Program and Associate Regional Director in the SEC\u2019s San Francisco Regional Office, commented on OCIE\u2019s 2018 priorities during a Q&amp;A panel the day after OCIE released them. She emphasized that OCIE employs a data-driven risk-based strategy to select individuals and entities for examination. The approach involves looking at factors that create the greatest possibility for liability and selecting exam subjects based on that risk analysis. This model does not mean that OCIE expects to find violations in those selected firms and priority areas, but rather that it will focus its resources in the areas that present the greatest risk. Indeed, Snyder noted that very few entities and individuals who are examined get referred to the SEC\u2019s Division of Enforcement, and of the few matters that are referred to Enforcement, even fewer result in charges.<\/p>\n<p>Snyder also emphasized that OCIE increasingly uses risk data analytics to scope entities and individuals for examination and to effectively carry out its priorities. Specifically, regional OCIE offices receive a spreadsheet from OCIE\u2019s home office that provides objective data analytics, such as firm size, that they use, along with their experience and other factors, to put entities or individuals on the exam list or to move their position on the list. Factors making entities or individuals more likely to be exam subjects include problems with prior exams, unusual changes in disclosures or involvement in lawsuits.<\/p>\n<p>Snyder also discussed a number of hot-button issues, including:<\/p>\n<ul>\n<li><strong><b>Fees:<\/b><\/strong> Snyder emphasized that OCIE is focused on fees for registered investment advisors and valuations for private fund advisors. Its priorities are largely identical to those articulated in <a href=\"https:\/\/www.sec.gov\/ocie\/Article\/risk-alert-advertising.pdf\">OCIE\u2019s September 14, 2017 Risk Alert<\/a> .<\/li>\n<li><strong><b>Valuations:<\/b><\/strong> Snyder said that OCIE would also continue to focus on valuation methodologies and disclosures with respect to private fund advisors.<\/li>\n<li><strong><b>Potential liability of Chief Compliance Officers (CCOs):<\/b><\/strong> When asked about the SEC\u2019s stance regarding individual liability for CCOs under the new Administration, Snyder referred <a href=\"https:\/\/www.sec.gov\/news\/speech\/keynote-address-2015-national-society-compliance-prof-cereseney.html\">to Former Enforcement Director Andrew Ceresney\u2019s November 2015 speech to the National Society of Compliance Professionals<\/a> and stated that the Commission\u2019s views on the subject remain unchanged: it remains focused on compliance officers who engage in fraud or egregious failures, obstruct investigations or exhibit a wholesale failure to carry out responsibilities. It thus appears that the change in Administration has not signaled a departure from OCIE\u2019s previous position on individual liability for CCOs: compliance officers who perform diligently and in good faith should not fear OCIE exams or enforcement actions. Snyder did, however, note the trend to outsource CCOs, particularly for smaller firms. She indicated that outsourcing the CCO role is not a <em><i>per se<\/i><\/em> problem or issue, but noted that some outsourcing firms are now servicing upwards of 20 investment advisors at a time, thus raising questions about whether they have the resources to adequately fulfill CCO duties.<\/li>\n<li><b><strong>ICOs:<\/strong> <\/b>Finally, Snyder said that OCIE would be looking at ICOs and whether advisors need to register because they are a \u201csecurity\u201d and, if so, whether they are complying with suitability and custody rules.<\/li>\n<\/ul>\n<p><strong><b>Tips and Best Practices<\/b><\/strong><\/p>\n<p>OCIE has emphasized that the 2018 list of priorities is not exhaustive, and that OCIE is not bound by the areas of focus described therein. Nonetheless, it seems likely that OCIE will devote the majority of its resources toward the stated priorities in the coming year. Companies and individuals would thus be well advised to focus efforts on ensuring that their compliance infrastructure is strong, particularly in announced areas of OCIE focus.<\/p>\n<p>One best practice for ensuring that a firm is in shape to address OCIE\u2019s priority issues and pass an exam is to conduct a mock OCIE exam. Entities and individuals who have previously been the subjects of OCIE exams have reported that conducting mock exams \u2013 often under the supervision of counsel, thus protecting the results under privilege \u2013 has prepared them for actual OCIE exams. In addition, entities and individuals should document all compliance issues, significant judgment calls and changes to their valuation methodology, so they have a record and are well prepared should the matter be questioned during an exam. As a best practice, this should be done upon advice of counsel and under privilege in the first instance to avoid creating liability.<\/p>\n<!-- AddThis Advanced Settings generic via filter on the_content --><!-- AddThis Share Buttons generic via filter on the_content -->","protected":false},"excerpt":{"rendered":"<p>On February 7, 2018 the SEC\u2019s 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 [&hellip;]<!-- AddThis Advanced Settings generic via filter on get_the_excerpt --><!-- AddThis Share Buttons generic via filter on get_the_excerpt --><\/p>\n","protected":false},"author":759,"featured_media":1436,"comment_status":"closed","ping_status":"closed","sticky":false,"template":"","format":"standard","meta":{"footnotes":""},"categories":[764,46],"tags":[1832,154,1835,1351,1058,1057,534],"coauthors":[1829,197],"class_list":["post-1657","post","type-post","status-publish","format-standard","has-post-thumbnail","hentry","category-client-alert","category-sec","tag-cryptocurrency","tag-finra","tag-ico","tag-msrb","tag-ocie","tag-office-of-compliance-inspections-and-examinations","tag-securities-and-exchange-commission"],"_links":{"self":[{"href":"https:\/\/blogs.orrick.com\/securities-litigation\/wp-json\/wp\/v2\/posts\/1657","targetHints":{"allow":["GET"]}}],"collection":[{"href":"https:\/\/blogs.orrick.com\/securities-litigation\/wp-json\/wp\/v2\/posts"}],"about":[{"href":"https:\/\/blogs.orrick.com\/securities-litigation\/wp-json\/wp\/v2\/types\/post"}],"author":[{"embeddable":true,"href":"https:\/\/blogs.orrick.com\/securities-litigation\/wp-json\/wp\/v2\/users\/759"}],"replies":[{"embeddable":true,"href":"https:\/\/blogs.orrick.com\/securities-litigation\/wp-json\/wp\/v2\/comments?post=1657"}],"version-history":[{"count":0,"href":"https:\/\/blogs.orrick.com\/securities-litigation\/wp-json\/wp\/v2\/posts\/1657\/revisions"}],"wp:featuredmedia":[{"embeddable":true,"href":"https:\/\/blogs.orrick.com\/securities-litigation\/wp-json\/wp\/v2\/media\/1436"}],"wp:attachment":[{"href":"https:\/\/blogs.orrick.com\/securities-litigation\/wp-json\/wp\/v2\/media?parent=1657"}],"wp:term":[{"taxonomy":"category","embeddable":true,"href":"https:\/\/blogs.orrick.com\/securities-litigation\/wp-json\/wp\/v2\/categories?post=1657"},{"taxonomy":"post_tag","embeddable":true,"href":"https:\/\/blogs.orrick.com\/securities-litigation\/wp-json\/wp\/v2\/tags?post=1657"},{"taxonomy":"author","embeddable":true,"href":"https:\/\/blogs.orrick.com\/securities-litigation\/wp-json\/wp\/v2\/coauthors?post=1657"}],"curies":[{"name":"wp","href":"https:\/\/api.w.org\/{rel}","templated":true}]}},{"id":1651,"date":"2018-01-30T13:21:43","date_gmt":"2018-01-30T18:21:43","guid":{"rendered":"http:\/\/blogs.orrick.com\/securities-litigation\/?p=1651"},"modified":"2018-02-12T10:10:47","modified_gmt":"2018-02-12T15:10:47","slug":"no-direct-cause-no-restitution","status":"publish","type":"post","link":"https:\/\/blogs.orrick.com\/securities-litigation\/2018\/01\/30\/no-direct-cause-no-restitution\/","title":{"rendered":"No Direct Cause, No Restitution"},"content":{"rendered":"<p>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 <a href=\"https:\/\/dlbjbjzgnk95t.cloudfront.net\/1004000\/1004554\/cftfc.pdf\">11th Circuit held<\/a> that investors whose losses were solely associated with registration violations by their fraudster traders were not entitled to a restitution award \u2013 because such losses had not been proximately caused by the registration violations.<\/p>\n<p>In an enforcement action brought by the Commodity Futures Trading Commission, the 11th Circuit affirmed a Florida district court\u2019s 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\u2019 losses.<!--more--><\/p>\n<p>By its terms, the CEA permits restitution only for \u201closses proximately caused by [a] violation.\u201d<a href=\"#_ftn1\" name=\"_ftnref1\"><sup>[1]<\/sup><\/a> Because no circuit court had analyzed proximate cause under the CEA, the 11th Circuit looked at courts\u2019 prior analyses of proximate cause under the Fair Housing Act (FHA). Just last year, the Supreme Court held that proximate cause under the FHA \u201crequires \u2018some direct relation between the injury asserted and the injurious conduct alleged,\u2019\u201d<a href=\"#_ftn2\" name=\"_ftnref2\"><sup>[2]<\/sup><\/a> thus overturning the 11th Circuit\u2019s previously articulated standard that awarded restitution if the losses were \u201ca reasonably foreseeable result of the defendant\u2019s violations.\u201d<a href=\"#_ftn3\" name=\"_ftnref3\"><sup>[3]<\/sup><\/a> Finding that the Supreme Court\u2019s common law approach to proximate cause should apply, the 11th Circuit reasoned that:<\/p>\n<p><em><i>[L]osing money is a foreseeable result of investing with an unregistered trader, but this is not because a trader\u2019s failure to register will itself cause any loss. More likely, any loss will result from some other factor, such as the trader\u2019s incompetence or dishonesty, which the failure to register correlates but does not cause. The intrinsic qualities of the trader <\/i><\/em><em><i>\u2013<\/i> not his or her failure to register <\/em><em><i>\u2013<\/i> would be the likely cause of the loss, to say nothing of market fluctuations.<\/em><a href=\"#_ftn4\" name=\"_ftnref4\"><sup>[4]<\/sup><\/a><\/p>\n<p>According to the 11th Circuit, the record did not contain evidence to support a finding that investors\u2019 losses were proximately caused by the traders\u2019 failure to register.<\/p>\n<p>Thus, not every regulatory violation translates to investor losses that can be recouped by the government; courts expect a showing that the losses were a direct result of the violation.<\/p>\n<p><a href=\"#_ftnref1\" name=\"_ftn1\"><sup>[1]<\/sup><\/a> 7 U.S.C. Section 13a-1(d)(3).<\/p>\n<p><a href=\"#_ftnref2\" name=\"_ftn2\"><sup>[2]<\/sup><\/a> <em><i>Bank of America Corp. v. City of Miami<\/i><\/em>, 137 S. Ct. 1296, 1306 (2017) (quoting <em><i>Holmes v. Sec. Inv\u2019r Protection Corp.<\/i><\/em>, 503 U.S. 258, 268 (1992)).<\/p>\n<p><a href=\"#_ftnref3\" name=\"_ftn3\"><sup>[3]<\/sup><\/a> <em><i>U.S. Commodity Futures Trading Commission v. Southern Trust Metals, Inc., et al.<\/i><\/em>, No. 16-16544 (11th Cir. 2018) (citing <em><i>City of Miami v. Bank of Am. Corp<\/i><\/em>., 800 F.3d 1262, 1282 (11th Cir. 2015)).<\/p>\n<p><a href=\"#_ftnref4\" name=\"_ftn4\"><sup>[4]<\/sup><\/a> <em><i>Id. <\/i><\/em><\/p>\n<!-- AddThis Advanced Settings generic via filter on the_content --><!-- AddThis Share Buttons generic via filter on the_content -->","protected":false},"excerpt":{"rendered":"<p>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 \u2013 because such losses had not [&hellip;]<!-- AddThis Advanced Settings generic via filter on get_the_excerpt --><!-- AddThis Share Buttons generic via filter on get_the_excerpt --><\/p>\n","protected":false},"author":759,"featured_media":1600,"comment_status":"closed","ping_status":"closed","sticky":false,"template":"","format":"standard","meta":{"footnotes":""},"categories":[496,1],"tags":[1834,247,250,278],"coauthors":[1829,1833],"class_list":["post-1651","post","type-post","status-publish","format-standard","has-post-thumbnail","hentry","category-financial-institutions","category-uncategorized","tag-11th-circuit","tag-cftc","tag-commodities-exchange-act","tag-commodity-futures-trading-commission"],"_links":{"self":[{"href":"https:\/\/blogs.orrick.com\/securities-litigation\/wp-json\/wp\/v2\/posts\/1651","targetHints":{"allow":["GET"]}}],"collection":[{"href":"https:\/\/blogs.orrick.com\/securities-litigation\/wp-json\/wp\/v2\/posts"}],"about":[{"href":"https:\/\/blogs.orrick.com\/securities-litigation\/wp-json\/wp\/v2\/types\/post"}],"author":[{"embeddable":true,"href":"https:\/\/blogs.orrick.com\/securities-litigation\/wp-json\/wp\/v2\/users\/759"}],"replies":[{"embeddable":true,"href":"https:\/\/blogs.orrick.com\/securities-litigation\/wp-json\/wp\/v2\/comments?post=1651"}],"version-history":[{"count":0,"href":"https:\/\/blogs.orrick.com\/securities-litigation\/wp-json\/wp\/v2\/posts\/1651\/revisions"}],"wp:featuredmedia":[{"embeddable":true,"href":"https:\/\/blogs.orrick.com\/securities-litigation\/wp-json\/wp\/v2\/media\/1600"}],"wp:attachment":[{"href":"https:\/\/blogs.orrick.com\/securities-litigation\/wp-json\/wp\/v2\/media?parent=1651"}],"wp:term":[{"taxonomy":"category","embeddable":true,"href":"https:\/\/blogs.orrick.com\/securities-litigation\/wp-json\/wp\/v2\/categories?post=1651"},{"taxonomy":"post_tag","embeddable":true,"href":"https:\/\/blogs.orrick.com\/securities-litigation\/wp-json\/wp\/v2\/tags?post=1651"},{"taxonomy":"author","embeddable":true,"href":"https:\/\/blogs.orrick.com\/securities-litigation\/wp-json\/wp\/v2\/coauthors?post=1651"}],"curies":[{"name":"wp","href":"https:\/\/api.w.org\/{rel}","templated":true}]}},{"id":1644,"date":"2018-01-09T10:08:16","date_gmt":"2018-01-09T15:08:16","guid":{"rendered":"http:\/\/blogs.orrick.com\/securities-litigation\/?p=1644"},"modified":"2020-02-27T18:18:37","modified_gmt":"2020-02-27T23:18:37","slug":"financial-derivatives-intermediaries-who-trade-virtual-currencies-face-the-nfas-enhanced-reporting-requirements","status":"publish","type":"post","link":"https:\/\/blogs.orrick.com\/securities-litigation\/2018\/01\/09\/financial-derivatives-intermediaries-who-trade-virtual-currencies-face-the-nfas-enhanced-reporting-requirements\/","title":{"rendered":"Financial Derivatives Intermediaries Who Trade Virtual Currencies Face the NFA\u2019s Enhanced Reporting Requirements"},"content":{"rendered":"<p>Derivatives regulators continue to take actions that pull virtual currencies \u2013 also known as digital currency or cryptocurrency, the best known of which is bitcoin \u2013 into their regulatory schemes. In December, the National Futures Association (NFA), the futures industry\u2019s 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.<\/p>\n<p>Specifically, the NFA\u2019s notices:<\/p>\n<ul>\n<li><a href=\"https:\/\/www.nfa.futures.org\/news\/newsNotice.asp?ArticleID=4973\">direct<\/a> 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);<\/li>\n<li><a href=\"https:\/\/www.nfa.futures.org\/news\/newsNotice.asp?ArticleID=4975\">direct<\/a> 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;<\/li>\n<li><a href=\"https:\/\/www.nfa.futures.org\/news\/newsNotice.asp?ArticleID=4974\">direct<\/a> 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\u2019s 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.<\/li>\n<\/ul>\n<p><!--more--><\/p>\n<p>Among regulators, the CFTC, the primary derivatives regulator in the US, and the futures industry SROs have shown themselves to be open to innovative products such as virtual currency. In fact, the CFTC has granted several approvals to companies seeking to trade virtual currency derivatives. Specifically, last summer it granted LedgerX LLC\u2019s application to register as a swap exchange facility and a derivatives clearing organization to trade and clear options on bitcoin, among other things. More recently, in December 2017, two of the principal futures exchanges, the CBOE and CME, self-certified cash-settled bitcoin futures, which are now actively trading on those exchanges.<\/p>\n<p>The SEC, on the other hand, has been slower to lend legitimacy to virtual currencies. The SEC rejected multiple applications to create an exchange-traded fund (ETF) tied to the value of bitcoin, and delayed consideration of two other ETF applications seeking to provide investors exposure to bitcoin futures markets.<\/p>\n<p>Notwithstanding their difference in approaches, the <a href=\"https:\/\/www.sec.gov\/news\/public-statement\/statement-clayton-stein-piwowar-010418\">SEC<\/a>, <a href=\"http:\/\/www.cftc.gov\/PressRoom\/SpeechesTestimony\/giancarlostatement010418\">CFTC<\/a> and <a href=\"http:\/\/www.nasaa.org\/44073\/nasaa-reminds-investors-approach-cryptocurrencies-initial-coin-offerings-cryptocurrency-related-investment-products-caution\/\">North American Securities Administrators Association<\/a> all issued statements in the past week warning investors to be diligent and cautious when participating in the cryptocurrency-related investment markets.<\/p>\n<p>Thus, while substantial doubt remains about bitcoin and other virtual currencies among sectors of the financial industry, economists, and the general public, the CFTC is permitting innovation in this area, subject to its review and oversight processes. It appears as though the NFA is following in that vein, permitting trading by its regulated financial intermediaries, while imposing on them enhanced reporting and notification requirements. While not an explicit embrace of these new products, it is not a rejection of them. Time will tell whether other regulators follow suit.<\/p>\n<!-- AddThis Advanced Settings generic via filter on the_content --><!-- AddThis Share Buttons generic via filter on the_content -->","protected":false},"excerpt":{"rendered":"<p>Derivatives regulators continue to take actions that pull virtual currencies \u2013 also known as digital currency or cryptocurrency, the best known of which is bitcoin \u2013 into their regulatory schemes. In December, the National Futures Association (NFA), the futures industry\u2019s self-regulatory organization, issued three Notices to Members that expand the notification and reporting requirements for [&hellip;]<!-- AddThis Advanced Settings generic via filter on get_the_excerpt --><!-- AddThis Share Buttons generic via filter on get_the_excerpt --><\/p>\n","protected":false},"author":759,"featured_media":1530,"comment_status":"closed","ping_status":"closed","sticky":false,"template":"","format":"standard","meta":{"footnotes":""},"categories":[46],"tags":[1446,247,1825,1794,1832,1827,1824,1826,1828,1823,239],"coauthors":[1829],"class_list":["post-1644","post","type-post","status-publish","format-standard","has-post-thumbnail","hentry","category-sec","tag-bitcoin","tag-cftc","tag-cpos","tag-cryptocurrencies","tag-cryptocurrency","tag-ctas","tag-fcms","tag-ibs","tag-national-futures-association","tag-nfa","tag-securities-exchange-commission"],"_links":{"self":[{"href":"https:\/\/blogs.orrick.com\/securities-litigation\/wp-json\/wp\/v2\/posts\/1644","targetHints":{"allow":["GET"]}}],"collection":[{"href":"https:\/\/blogs.orrick.com\/securities-litigation\/wp-json\/wp\/v2\/posts"}],"about":[{"href":"https:\/\/blogs.orrick.com\/securities-litigation\/wp-json\/wp\/v2\/types\/post"}],"author":[{"embeddable":true,"href":"https:\/\/blogs.orrick.com\/securities-litigation\/wp-json\/wp\/v2\/users\/759"}],"replies":[{"embeddable":true,"href":"https:\/\/blogs.orrick.com\/securities-litigation\/wp-json\/wp\/v2\/comments?post=1644"}],"version-history":[{"count":0,"href":"https:\/\/blogs.orrick.com\/securities-litigation\/wp-json\/wp\/v2\/posts\/1644\/revisions"}],"wp:featuredmedia":[{"embeddable":true,"href":"https:\/\/blogs.orrick.com\/securities-litigation\/wp-json\/wp\/v2\/media\/1530"}],"wp:attachment":[{"href":"https:\/\/blogs.orrick.com\/securities-litigation\/wp-json\/wp\/v2\/media?parent=1644"}],"wp:term":[{"taxonomy":"category","embeddable":true,"href":"https:\/\/blogs.orrick.com\/securities-litigation\/wp-json\/wp\/v2\/categories?post=1644"},{"taxonomy":"post_tag","embeddable":true,"href":"https:\/\/blogs.orrick.com\/securities-litigation\/wp-json\/wp\/v2\/tags?post=1644"},{"taxonomy":"author","embeddable":true,"href":"https:\/\/blogs.orrick.com\/securities-litigation\/wp-json\/wp\/v2\/coauthors?post=1644"}],"curies":[{"name":"wp","href":"https:\/\/api.w.org\/{rel}","templated":true}]}}]