A margin account is a type of investment account that allows investors to borrow funds from their broker-dealer to purchase securities. With a margin account, investors are able to leverage their trades by borrowing against the value of their portfolio. This means that investors can potentially earn larger returns on their investments but also exposes them to increased risk.

Broker-dealers have a number of responsibilities when it comes to margin accounts. One of their primary responsibilities is to ensure that investors understand the risks associated with trading on margin. This includes providing investors with a detailed explanation of how margin accounts work, the potential risks and benefits, and any costs or fees associated with trading on margin.

Another important responsibility of broker-dealers is to ensure that investors meet the eligibility requirements for trading on margin. These requirements may vary depending on the broker-dealer, but typically include factors such as an investor’s financial standing, trading history, and investment objectives. Broker-dealers must also maintain appropriate documentation to demonstrate that investors meet these requirements.

Once an investor has been approved for a margin account, broker-dealers are responsible for monitoring the account to ensure that the investor is maintaining sufficient collateral to cover any potential losses. This is known as a margin call. If the value of the investor’s portfolio falls below a certain level, the broker-dealer may issue a margin call, requiring the investor to deposit additional funds or securities to maintain the required level of collateral.

Broker-dealers should clarify for investors that the broker-dealer has almost unfettered control over the margin account. The broker-dealer, in the face of a ‘margin call,’ can raise money to meet the margin call by selling stocks from an investor’s account without first asking the investor. The broker dealer can even sell out the entire account without the client’s authority to protect the broker-dealer.

Broker-dealers are also subject to the Financial Industry Regulatory Authority’s (FINRA) rules regarding margin accounts. These rules require broker-dealers to provide investors with a risk disclosure statement outlining the risks associated with trading on margin. Broker-dealers must also provide investors with regular statements outlining the status of their margin accounts, including the amount of margin used and any potential margin calls. Additionally, broker-dealers must also comply with all applicable laws and regulations governing their conduct, including the Securities Exchange Act of 1934 and the Investment Advisers Act of 1940.

Another important responsibility that broker-dealers have is the responsibility to ensure that all investors are treated fairly and with integrity. This includes providing investors with accurate and timely information about their margin accounts, as well as ensuring that any fees or charges associated with trading on margin are reasonable and transparent. Broker-dealers must also have adequate safeguards in place to protect investors’ assets and prevent unauthorized access or theft.

Margin accounts offer investors the opportunity to potentially earn larger returns on their investments, but such accounts also come with increased risk. Broker-dealers have a number of important responsibilities when it comes to margin accounts, including ensuring that investors understand the risks and benefits of trading on margin, monitoring accounts to ensure sufficient collateral, preventing illegal trading practices, and complying with applicable regulations. As an investor, it’s important to work with a reputable broker-dealer who is committed to transparency, fairness, and integrity when it comes to margin accounts.

Along with the sharing his viewpoint that the majority of crypto tokens and cryptocurrency intermediaries are subject to federal securities laws and regulations, Gensler also shared a quote from the first SEC Chairman, Joseph Kennedy: “No honest business need fear the SEC.” [1] Gensler’s repeated reference to this quote supported his overarching message that regulatory oversight of crypto tokens and intermediaries should be viewed as a positive for the market rather than a negative.

In first speaking on crypto tokens themselves, Gensler noted that the purchase and sale of these tokens are subject to federal securities laws so long as the tokens meet the statutory definition of a security. Gensler cited Congressional purpose and history as well as the Supreme Court’s “Howey Test” in support of his view. [1]

Gensler pointed out that Congress intended a broad scope for the definition of a security, citing Justice Thurgood Marshall’s statement that “Congress’ purpose in enacting the securities laws was to regulate investments, in whatever form they are made and by whatever name they are called.” [1]

Gensler then turned to the Supreme Court’s “Howey Test,” which sets forth the factors that comprise one form of security: an “investment contract.” [1] In line with the Howey Test, Gensler concluded that, because crypto investors buy and sell crypto tokens with the expectation of “profits derived from the efforts of others in a common enterprise,” the tokens are indeed investment contracts; thus, they are securities subject to federal securities laws.

Beyond discrete crypto tokens, Gensler also stated that the intermediaries, which host the exchange of crypto tokens, must also likely register with the SEC in order to comply with federal securities laws. Crypto intermediary platforms “match orders in crypto security tokens of multiple buyers and sellers using non-discretionary methods,” and this meets the legal test for regulatory oversight.

While Gensler views the majority of crypto tokens and cryptocurrency intermediaries as subject to regulation and oversight by the SEC, his remarks sought to underscore the merits of such regulation for all market participants.

He noted that those offering crypto tokens or operating crypto intermediary platforms should have open dialogues with the SEC to help ensure that any token or platform which legally requires registration with the SEC may avoid potential legal issues in the future.

Gensler also emphasized the important investor protections offered by SEC oversight of crypto tokens and intermediaries. In concluding his remarks, Gensler highlighted his view that crypto simply offers a new technology for the issuance and trading of securities, and the adoption of a new technology should not deprive the investing public of the critical benefits offered by required disclosures and registration with the SEC.

Although Gensler’s remarks are not representative of official guidance from the SEC, they shed light on the importance of regulating crypto markets, specifically as they expand in popularity and adoption by the general public. With regulatory oversight under existing federal securities laws, crypto investors gain important assurance of the legitimacy and safety of their investment portfolios.

Source:

[1] https://www.sec.gov/news/speech/gensler-sec-speaks-090822

Before sharing his view of the SEC’s role in crypto markets, Chairman Gensler first compared the technology to that of the dotcom bubble in 2000 and subprime lenders leading up to the 2008 financial crisis. His message: the flurry of attention on crypto and related innovations does little to vouch for its long-term viability or success. Instead, as was borne out in 2000 and again in 2008, cryptocurrency could indeed be a technology destined for failure.

The SEC’s role then, in Gensler’s view, is to protect investors from the potential financial blowback of such a failure. While Gensler lauded the spirit of entrepreneurship common in the United States, he also argued that the SEC should approach crypto regulation in a “technology neutral” way. In so doing, the SEC could carry out their mission to protect investors, facilitate capital formation, and maintain fair, orderly, and efficient markets, while still allowing crypto markets to flourish.

Gensler chose to focus on three discrete areas in which the SEC might appropriately step in with a regulatory scheme: crypto trading and lending platforms, stablecoins, and crypto tokens.

First, on the topic of crypto trading and lending platforms, Gensler noted the importance of these platforms being registered, thus allowing regulation in a similar manner to regulation of traditional securities exchanges. Gensler argued that in light of the functional similarities between “traditional regulated exchanges” and crypto platforms, investors on crypto platforms deserve similar regulatory protections. Such investor protections, Gensler noted, in turn promote investor confidence, which allows markets to work.

According to Gensler, stablecoins, which can be likened to bank deposits or money market funds, pose their own differing set of potential policy considerations. Stablecoins are rarely used in commerce, are not a legal tender, and are not issued by any central government.

As a result, stablecoins may impact monetary policy and financial stability within larger markets, may facilitate illicit activity, and may put U.S. investors at risk of losses created by unique conflicts of interest. Such conflicts arise because many of the platforms on which stablecoins are traded also physically own the stablecoins they trade.

Finally, Gensler approached the topic of the SEC’s regulation of all other crypto tokens. Most notably, Gensler stated that most crypto tokens are “securities” or “investment contracts” under U.S. law, thus necessitating registration by the SEC pursuant to existing federal securities laws.

The U.S. Supreme Court has held that an investment contract, or security, exists “when there is the investment of money in a common enterprise with a reasonable expectation of profits to be derived from the efforts of others.”

Gensler noted that many crypto tokens are being sold by entrepreneurs who are looking to raise money from the public. This use-case places crypto tokens squarely within the definition of security or investment contract, and thus, submits crypto tokens to federal oversight. Regulation of crypto markets in this way safeguards not only crypto investors, but also the broader stability of the economy.

While Gensler emphasized that the views in his speech were his own and not representative of the SEC, his perspective will likely impact the SEC as it moves forward with enforcement policy. In the interim, Savage Villoch attorneys are available to consult on your cryptocurrency investment questions or concerns!

Sources: [1] https://www.investopedia.com/tech/question-why-should-anyone-invest-crypto/#:~:text=Another%20common%20reason%20to%20invest,dilute%20their%20value%20through%20inflation.

[2] https://www.sec.gov/news/speech/gensler-remarks-crypto-markets-040422

Understanding the new rules necessitates a working understanding of SPACs themselves. SPACs are a form of “blank-check” company, in which capital is raised by investors through an Initial Public Offering (IPO). [2] SPAC IPOs differ greatly from traditional IPOs, however, in that at the time of a SPAC IPO, the SPAC has no physical operations of its own. [2] Instead, post-IPO, a SPAC is granted a two year term during which it must acquire or merge with an existing company, thereby taking that company public without ever going through the traditional, and often costly, IPO process. [2]

New SPAC IPOs have been on a meteoric rise since 2020. In 2019, just 59 SPAC IPOs occurred, while 2020 saw 247 and 2021 saw a record 613 SPAC IPOs. [2] These 613 SPAC IPOs in 2021 represented over $160 billion of capital raised. [2]

Yet even with the number of SPAC IPOs growing rapidly, the actual financial of SPACs is currently lagging behind index funds, which track to the S&P 500. [3] In fact, the ETF which tracks the prices of companies which stem from SPAC IPOs is down 33% year over year, while the S&P 500 is up 17% over the same time period. [3]

This performance disparity perfectly highlights the SEC’s core rationale for introducing SPAC disclosure rules. At present, SPACs raise money through IPOs with minimal disclosure requirements. More striking, the companies they eventually acquire or merge with are not subject to typical disclosure requirements either – leaving investors uniquely vulnerable to fraudulent misrepresentations.

The SEC’s newly proposed rules present an opportunity to clarify some aspects of the SPAC IPO process for prospective investors.

First, the rules, if enacted, would require new disclosures from and about SPAC sponsors, conflicts of interest, and dilution sources. [4] First, the rule proposes the adoption of a broad definition of SPAC sponsors as “the entity and/or person(s) primarily responsible for organizing, directing, or managing the business and affairs of a SPAC. . .” [4]

The rule further requires disclosures regarding conflicts of interest between SPAC sponsors and their public investors. [4] Such a conflict of interest could potentially arise if one SPAC sponsor is in the process of sponsoring multiple SPACs, or if a SPAC acquires a private company in which the SPAC’s sponsor already holds some financial interest. [4]

Additionally, the new rules look to better tackle issues relating to forward-looking projections made both by SPACs and by their potential target companies, further demystifying SPAC processes for their investors. [1]

In announcing the proposed rule, SEC Chair Gary Gensler harkened back to Congress’s initial attempt at addressing information asymmetries, misleading information, and conflicts of interest over 90 years ago when it first created the SEC in the wake of the 1929 market crash. [1] Gensler then noted that because, functionally, SPAC IPOs present firms with an alternative to traditional IPOs, investors “deserve the protections they receive from traditional IPOs, with respect to information asymmetries, fraud, and conflicts, and when it comes to disclosure, marketing practices, gatekeepers, and issuers.” [1]

The SEC’s proposed rule will be subject to a 60-day public comment period before ultimately being adopted by the regulator. If enacted in much the same format as the rules currently stand, investors stand to gain critical information about the true viability of SPACs in which they choose to invest.

As news around this proposed rule develops, Savage Villoch attorneys are ready to handle your questions or concerns. Reach out for consult today!

Sources:

[1] https://www.sec.gov/news/press-release/2022-56

[2] https://www.investopedia.com/terms/s/spac.asp

[3] https://www.forbes.com/sites/jonathanponciano/2022/03/30/sec-unveils-new-spac-rules-targeting-unreasonable-financial-projections-and-requiring-more-disclosures/?sh=6395435c74dd

[4] https://www.sec.gov/rules/proposed/2022/33-11048.pdf

The SEC has proposed rules which would require those registered with the SEC to disclose specific information regarding their climate-related financial risks and climate-related financial metrics. [2] This information would be disclosed to the SEC through an entity’s typical registration statements or annual reports, which already contain many other required disclosures. [2]

Importantly, the draft rules require companies registered with the SEC to disclose both their direct and indirect greenhouse gas emissions. These emissions include three discrete categories – Scope 1, Scope 2, and Scope 3. [3] Scope 1 greenhouse gas emissions are those emitted directly by the company through its operations, while Scope 2 emissions are the “indirect” emissions stemming from a company’s energy usage, such as through electricity generation. [4]

Of greater controversy, however, the proposed rules also require disclosure of any Scope 3 emissions a company deems “material” or that are included in a company’s self-appointed emissions targets. [3] Scope 3 emissions are those emitted not directly or even indirectly by a company itself, but rather by the company’s upstream or downstream suppliers and partners. [1]

Though the emissions of a supplier or partner may appear attenuated from a company’s own operations, the breadth of today’s globally connected supply chains seems to necessitate some consideration of these emissions, particularly in the limited cases for which the SEC proposes to mandate their disclosure. In particular, the SEC has carved out a legal safe harbor to guard small companies from the potentially prohibitive costs involved in Scope 3 emissions reporting. [1]

Beyond disclosure of climate-related risks and greenhouse gas emissions, the SEC’s new draft rule also require registrants to disclose any “actual or likely material impacts” that the climate-related risks they face might have on their “business, strategy, and outlook.” [3] These “climate-related risks” can be of any kind, meaning companies will likely need to take stock of both physical threats to their business from climate change – like risks stemming from coastal flooding or other extreme weather events – as well as financial threats – like the ways in which future climate change legislation or a potential carbon tax might impact the company’s bottom line.[3]

While conservative critics argue that the new rules on climate are an overstep of the SEC’s regulatory authority, SEC Chair Gary Gensler and many activist investors disagree. [3] Citing the rapid expansion in investor interest in environmental, social, and governance (ESG) focused funds, Gensler has noted that these rules carry out the SEC’s core mission in ensuring investors have access to “decision-useful” information about the funds in which they invest. The SEC notes that the proposed disclosure requirements are indeed “decision useful” in that they will provide investors with “consistent, comparable, and reliable” information from which investors may make informed decisions about the ways in which climate-related risks might impact their portfolios. [1]

As of today, these climate-related disclosures are still only proposed rules – meaning their next step is public comment, followed by the issuance of a final rule, like within the next year. [3] Critics, including the U.S. Chamber of Commerce, are sure to legally challenge these rules should they be formally adopted. Yet the clear investor demand and the value of data passed on to investors relating to the climate change-causing GHG emissions and the attendant risks a company faces should not be understated.

If you have questions on how the SEC’s new climate-related disclosure rules might impact you, your investments, or your business, the attorneys at Savage Villoch Law are available for consult.

Sources: [1] https://www.sec.gov/news/press-release/2022-46 [2] https://www.sec.gov/rules/proposed/2022/33-11042.pdf [3] https://www.reuters.com/legal/litigation/us-sec-set-unveil-landmark-climate-change-disclosure-rule-2022-03-21/ [4] https://www.compareyourfootprint.com/difference-scope-1-2-3-emissions/

At the time the tweet was posted in 2018, the SEC swiftly charged both Tesla and Musk with securities fraud, over which the parties eventually settled. [1] Now more than three years later, the public has learned of a new subpoena from the SEC relating to the tweet, though the subpoena’s impact and strategic aim are still to be seen.

As evidenced by this series of events, Tesla and the SEC share a turbulent, history. Following the 2018 “funding secured” tweet, the SEC alleged that Musk violated Section 10(b) of the Securities Exchange Act of 1934 along with rule 10b-5.[2] These allegations were based upon the SEC’s contention that the tweet constituted a materially false and misleading statement because despite Musk’s confident tone, he had neither discussed nor confirmed the terms of such a deal with any potential funding source. [2]

The SEC also alleged a securities fraud violation against Tesla in connection with Musk’s 2018 tweet, alleging that the company had violated Rule 13a-15 of the Exchange Act. [3] The regulator contended that in failing to have “sufficient processes in place to ensure that the information Musk published via his Twitter account was accurate [and] complete,” Tesla too had violated federal securities law. [3]

Within its complaint, the SEC noted that Tesla had notified the greater market in 2013 that the company planned to leverage Elon Musk’s Twitter account to share material information about the company with investors. [3] Despite this public strategy, the SEC alleged that necessary disclosure controls had not been implemented by Tesla to ensure that Musk’s tweets were indeed accurate and complete. [4]

While neither Elon Musk nor Tesla admitted to or denied the complaints against them, they each settled with the SEC in 2018. With the settlements came a $20 million fine for each party, along with several other avenues of relief. [4] Some of these settlement terms included that Musk was to step down from his role as Chairman of Tesla for a period of at least three years, as well as the appointment of new independent directors to Tesla’s board. [4]

Additionally, and directly connected to Tesla’s current headlines, the settlement required that a new committee made up of independent directors would be formed, along with increased controls and procedures for overseeing Musk’s online communications, like the 2018 tweet. [4]

The new subpoena, filed in November 2021 and disclosed within Tesla’s recently released annual report via a form 10-K, sheds light on the SEC’s continued oversight strategy of Musk’s public statements regarding Tesla. [1][5] The subpoena was issued on the heels of a Twitter poll posted by Musk. [5] In the poll, Musk asked Twitter users if they thought he should sell ten percent of his stake in the company, to which the market clearly responded – Tesla’s stock price fell 10% shortly thereafter.[5]

Since the 2018 tweet and SEC complaints, Musk has continued to post tweets instigating flurries of market activity amongst investors, and the new subpoena makes it clear that the SEC has continued to monitor Musk’s statements accordingly. [1]

For investors and publicly-traded companies alike, the ongoing SEC-Musk saga is a reminder that no matter how informal a communication may appear, there may well be potential securities law implications. The attorneys at Savage Villoch are equipped to counsel those with questions involving online communications like this one.

Sources: [1] https://www.barrons.com/articles/tesla-sec-subpoena-elon-musk-funding-se}cured-tweet-51644242712 [2] https://www.sec.gov/litigation/complaints/2018/comp-pr2018-219.pdf [3] https://www.sec.gov/litigation/complaints/2018/comp-pr2018-226.pdf [4] https://www.sec.gov/news/press-release/2018-226 [5] https://techcrunch.com/2022/02/08/sec-subpoenas-tesla-over-settlement-regarding-musks-tweets/

Under existing federal law, private firms with less than 2,000 shareholders are not required to register with the SEC nor provide routine disclosures, unlike their public counterparts. [1]

While exemption from such regulatory requirements may provide private startup companies with the freedom to develop their business unimpeded by government, thus encouraging valuable innovation, the rapid growth of the private capital market has experts questioning whether some degree of SEC oversight may be warranted.

In fact, during her remarks at the “SEC Speaks in 2021” event held in October 2021, SEC Commissioner Allison Herren Lee signaled that the regulatory body is in the beginning stages of evaluating whether they may indeed have an obligation to consider “address[ing] the reduced transparency in U.S. equity markets” brought on by private market growth. [2]

So, what exactly does recent growth in the private market look like? To start, over two thirds of the capital currently being raised is being raised privately, in essence dwarfing that which is raised publicly. [3] What’s more, the number of “unicorns,” or private companies with valuations of more than $1 billion dollars, has skyrocketed from just 40 in 2013 to over 900 today. [1],[4]

But why does this explosive growth matter to the SEC, or even to the average investor?

According to Commissioner Allison Herren Lee, the shift of capital from public to private markets is akin to a large swath of the market, and thus the economy, “going dark.” [2] As private companies continue to raise billions of dollars from investors without any true pressure to go public, the rest of the world, and even the company’s investors themselves, remain largely in the dark about the company’s true operations and financial position. [2]

This lack of transparency poses risks not only to wealthy individual investors and employees who hold equity in the private firms for which they work. There are also risks to those whose retirement assets are invested indirectly in private markets through institutional investors. [2]

Furthermore, the sheer size of the private market and its continued growth poses other systemic issues, including the possibility of obscuring climate change or other Environmental, Social, and Governance (ESG) risks that these companies face or perpetuate. [2]

The Theranos saga is illustrative of some of the myriad risks posed by unicorn companies in the absence of regulatory requirements from the SEC. Theranos was a company which purported to have produced a “portable blood analyzer” which would “revolutionize the blood testing industry,” though in actuality the product did not function as was represented. [5]

Ultimately, Theranos and its management were charged by the SEC for making false statements about their business and technology in violation of the anti-fraud provisions of federal securities laws. [5] Theranos had raised more than $700 million from private investors and venture capitalists, and while its value topped $10 billion in 2015, it was completely liquidated, and worthless, by 2018. [6]

The lesson here is evident – as capital continues to shift from public to private markets, investors are at greater risk of falling prey to a fraudulent scheme like that of Theranos, and the broader economy may well feel the aftershocks. When private startups raise large sums of money in the absence of mandated SEC disclosures, their value may well be inflated, and investors may not find out until their money is already lost.

While the SEC is still in the early stages of considering new reporting requirements for large private firms, this is a key area for investors to keep their eyes on in the coming months.

Sources: [1] https://www.wsj.com/articles/sec-pushes-for-more-transparency-from-private-companies-11641752489 [2] https://www.sec.gov/news/speech/lee-sec-speaks-2021-10-12#_ftnref20 [3] https://www.forbes.com/sites/anatalonbeck/2021/10/15/going-dark-the-explosive-growth-of-private-markets-and-other-thoughts-on-sec-commissioner-lees-remarks/?sh=63ed2b9d21c0 [4] https://www.cbinsights.com/research-unicorn-companies [5] https://www.sec.gov/news/press-release/2018-41 [6] https://www.investopedia.com/articles/investing/020116/theranos-fallen-unicorn.asp#:~:text=the%20same%20day.-,Theranos%20Inc.%2C%20a%20consumer%20healthcare%20technology%20startup%2C%20was%20once,venture%20capitalists%20and%20private%20investors.

In total, the number of new enforcement actions filed by the SEC in FY 2021 increased by 7% over the previous year, with 434 new enforcement actions. While the total number of enforcement actions – including new actions along with other “follow-on” or open proceedings – decreased slightly year over year in FY 2021, the SEC remained committed to its role as “cop on the beat for America’s securities laws,” as described by Chair Gary Gensler. [1] The SEC maintained a sharp focus on protecting the integrity of the country’s capital markets through enforcement actions against bad actors even in the face of the persisting COVID-19 pandemic persisted.

In announcing its progress on enforcement actions during FY 2021, the SEC concentrated on several key priority areas. Some of these priority areas, per a recent SEC Press Release, included “holding individuals accountable,” “ensuring gatekeepers live up to their obligations,” “rooting out misconduct in crypto,” “policing financial fraud and issuer disclosure,” “cracking down on insider trading and market manipulation,” and “swiftly acting to protect investors.” [1]

While focusing on “holding individuals accountable,” the SEC noted that during FY 2021, it successfully lodged charges against top-level executives of corporate powerhouses. including CEOs at both Wells Fargo and Nikola, an alternative-fuel trucking company. [1]

In “ensuring gatekeepers live up to their obligations,” the SEC focused its attention on auditors and attorneys from various backgrounds who had behaved improperly, unprofessionally, or failed in their duties when auditing other companies. [1]

The SEC was able to further its “rooting out misconduct in crypto,” objective by carefully studying misconduct within the emerging cryptocurrency market, and subsequently charging both entities and individuals who fraudulently offered digital asset securities, such as bitcoin, thereby defrauding investors. [1] These actions garnered particular concern, given the largely unregulated state of the cryptocurrency space.

Beyond cryptocurrency concerns, the SEC also proved its focus on “policing financial fraud and issuer disclosure,” by continuing to diligently trace potentially fraudulent activities within the market. In doing so, the SEC uncovered possible violations of securities laws, and also investigated disclosures made by public companies which improperly failed to note potential COVID-19 pandemic impacts on their businesses. [1]

During FY 2021 the SEC also had its eyes on “cracking down on insider trading and market manipulation” by pursuing charges for insider trading relating to a biopharmaceutical company acquired by COVID-19 vaccine manufacturer Pfizer, Inc., as well as an insider trading ring connected to confidential data regarding Netflix’s subscriber growth over time. [1]

In pursing its myriad enforcement actions, the SEC also focused on “swiftly acting to protect investors” throughout FY 2021. Many cases involved the SEC filing emergency actions or restraining orders against defendants in Ponzi schemes, as well as suspending trading of more than 20 “meme stocks,” as concerns about market volatility reached a head in early 2021. [1]

In all, the SEC’s FY 2021 enforcement actions resulted in obtaining “judgments and orders for nearly $2.4 billion in disgorgement and more than $1.4 billion in penalties.” [1] Furthermore, FY 2021 was the highest year ever for whistleblower awards, as the whistleblower program awarded $564 million to just over 100 whistleblowers, and surpassed $1 billion in lifetime awards paid out. [1]

As the world rebuilds and adapts to life in the midst of a global pandemic, the SEC looks poised to continue its work in closely monitoring and enforcing federal securities laws through enforcement actions, with the ultimate aim of protecting not only capital markets, but also investors of all backgrounds.

Sources: [1] https://www.sec.gov/news/press-release/2021-238

In support of this broad mission, the SEC established a whistleblower program and a corresponding Office of the Whistleblower to administer the program in 2012. The whistleblower program was established under Section 922 of the Dodd-Frank Wall Street Reform and Consumer Protection Act, which added Section 21F to the Securities Exchange Act of 1924 (“the Exchange Act”). [2]

Through this statutory addition, the SEC gained authorization to make monetary awards to “eligible whistleblowers.” These “eligible whistleblowers” are individuals who voluntarily come forward to the SEC with original information about a potential federal securities law violation, which ultimately leads to a successful SEC enforcement action imposing a monetary sanction of over $1 million. [3] Importantly, the Dodd Frank Act protects the confidentiality of all SEC whistleblowers, and no identifying information that could potentially reveal a whistleblower’s identity is released to the public. [4]

At its core, Section 21F of the Exchange Act provides a powerful framework for incentivizing whistleblowers to come forward with “original, timely and credible information” about potentially unlawful activity in the federal securities law space. [4]

In fact, in the almost ten years since the SEC’s whistleblower program was established, the SEC has awarded over $1 billion in whistleblower awards. This $1 billion has been awarded across a group of just over 200 individual whistleblowers, and individual awards vary drastically depending on the case, ranging from under $500,000 to the current high of $114 million awarded in October 2020. [4]

These awards are calculated at 10 to 30% of the money collected in an eligible enforcement action, and they never come from harmed investors. Instead, the awards are sourced from an account created by the United States Treasury Department, the Investor Protection Fund (“IPF”). [2]

Current SEC Chair, Gary Gensler, remains supportive of the whistleblower program, remarking in September 2021 after whistleblower awards topped $1 billion that “[t]he assistance that whistleblowers provide is crucial to the SEC’s ability to enforce the rules of the road of our capital markets.” [4]

The 2021 fiscal year was a record-breaking one, with over $500 million awarded to whistleblowers, and the 2022 fiscal year, which began on October 1, is already off to a quick start. On October 25, 2021, a joint whistleblower award topping $1.5 million was awarded to individuals who voluntarily came forward to the SEC with information about alleged wrongdoings, involved parties, and witness credibility – all of which helped the SEC efficiently conduct their investigation. [5]

Under the current administration, the SEC looks poised to continue encouraging whistleblowers who can similarly alert the SEC to unlawful activity under federal securities laws. These efforts are pivotal in the SEC’s efforts to continually prioritize investor and market protections.

Sources [1] https://www.sec.gov/about.shtml [2] https://www.sec.gov/news/press-release/2020-219 [3] https://www.sec.gov/whistleblower/frequently-asked-questions#faq-2 [4] https://www.sec.gov/news/press-release/2021-177 [5] https://www.natlawreview.com/article/sec-awards-over-15-million-to-joint-whistleblowers

In fact, the SEC has recently begun sanctioning the very victims of cyberattacks – investment firms that have fallen prey to such attacks – citing their deficient cybersecurity procedures as partly to blame for the unauthorized third-party access to investor’s private information. [1]

On August 30, 2021, the SEC released three orders sanctioning eight firms for their failures in protecting their customers’ personally identifiable information due to inadequate cybersecurity policies and procedures. These orders each proceeded as violations of Rule 30(a) of Regulation S-P, colloquially known as the “Safeguards Rule.” [2]

The Safeguards Rule requires that any broker-dealer or investment adviser registered with the SEC adopts “written policies and procedures reasonably designed to:

(1) insure the security and confidentiality of customer records and information;

(2) protect against any anticipated threats or hazards to the security or integrity of customer records and information; and

(3) protect against unauthorized access to or use of customer records or information that could result in substantial harm or inconvenience to any customer.” [3]

In response to the orders, each firm settled with the SEC without admitting to nor denying the charges, paying a sum total of $750,000 in penalties. [2]

The first order was lodged against Cetera Advisor Networks LLC, Cetera Investment Services LLC, Cetera Financial Specialists LLC, Cetera Advisors LLC, and Cetera Investment Advisers, LLC (collectively “Cetera Entities”) for failing to adequately leverage the myriad tools they had available to mitigate cybersecurity risks, resulting in a violation of the Safeguards Rule. [3]

From November 2017 to June 2020, unauthorized third parties gained access to the emails of over 60 Cetera Entities personnel, exposing more than 4,000 Cetera Entities customers’ personally identifiable information. The SEC alleged that while Cetera had the ability to implement multi-factor authentication (“MFA”) on email accounts, none of the compromised emails had enabled that security feature. [3]

As a result, the SEC concluded that Cetera Entities violated the Safeguards Rule because their “policies and procedures to protect customer information and to prevent and respond to cybersecurity incidents were not reasonably designed” to adequately protect their customers’ PII. [3]

The second order alleged that Cambridge Investment Research, Inc., and Cambridge Investment Research Advisors, Inc., willfully violated the Safeguards Act in a similar manner by failing to activate MFA on the cloud-based email accounts of their registered representatives. [4] As a result of this failure, more than 121 Cambridge representatives’ cloud-based email accounts were breached by third parties, exposing the personally identifiable information of more than 2,000 Cambridge customers. [4]

Finally, the SEC’s third order alleging a violation of the Safeguards Rule was entered against KMS Financial Services, Inc., again for failing to properly safeguard the cloud-based email accounts of the company’s registered financial advisers. [5] The result of this failure was exposure of sensitive personally identifiable information of nearly 5,000 KMS customers. In addition, the SEC found that even after KMS became aware of the unauthorized third-party breach in November 2018, it failed to adopt firm-wide increased security measures relating to email accounts for more than 20 months. [5]

The release of these three orders clearly signals the SEC’s desire to protect investor data held by broker-dealer firms across the United States, essentially forcing the adoption of increased security measures across the industry. Interestingly, each of the three orders explicitly notes that the email breaches in question “do not appear” to have resulted in any realized financial damages to the customers via their compromised accounts.

Given this information, these SEC actions appear almost cautionary in nature, attempting to serve as a warning to all broker-dealer firms as they design their cybersecurity policies. While these policies may impose costs on investment firms, the interests of investors are well-served by this stance on protecting personal information.

Sources: [1] https://www.reuters.com/legal/legalindustry/cyber-attack-victims-face-one-two-punch-sec-ramps-up-enforcement-actions-2021-10-12/ [2] https://www.sec.gov/news/press-release/2021-169 [3] https://www.sec.gov/litigation/admin/2021/34-92800.pdf [4] https://www.sec.gov/litigation/admin/2021/34-92806.pdf [5] https://www.sec.gov/litigation/admin/2021/34-92807.pdf

According to the SEC’s complaint, Sky Group ran its fraudulent scheme from at least January 2016 through March 2020. During this time, Sky Group raised approximately $66 million through the sale of promissory notes while representing itself as a payday lender soliciting investors to fund its business. [2]

In particular, Sky Group targeted Venezuelan-American investors in South Florida, who in turn often spread information about the investment opportunity by word-of-mouth. Betancourt specifically pitched Sky Group investments as “a great opportunity for members of the Venezuelan immigrant community to generate investment income,” touting its supposed $70 million loan portfolio as evidence of the investment’s safety.

Sky Group investors each signed a Sky Group “Loan Agreement and Promissory Note” which formed the basis of the agreement in which the investors would receive monthly interest payments and the return of their principal after one year. [2] Annual interest rates were advertised from 24 to 120 percent, and such rates often served as one of the main factors in securing investors. [2]

In all, Sky Group recruited between 505 and 685 retail investors under this guise, most of whom purchased promissory notes with principal values ranging from $10,000 to $150,000, with an outlier having invested $1.1 million. [2] Sky Group and Betancourt employed outside sales agents to contact and pitch the investment to potential investors; none of whom were registered as brokers nor associated with registered broker-dealers. [2] Betancourt also frequently met investors in person, over the phone, and via email to secure their buy-in personally. [2]

While Sky Group investors were assured that their investments would be used solely for consumer payday loans and any costs associated with them, the reality was quite different. Of the $66 million it raised from investors, Sky Group used less than 20% for consumer payday loans. [2] It also only received $20.5 million in customer loan repayments, a far cry from the $70 million loan portfolio it advertised to investors as a reserve for repayment if needed. [2]

As for the remaining 80% of investor dollars, Sky Group improperly used about $12 million on its operating expenses, almost $10 million to pay its sales agent commissions, $19.2 million to simply repay prior investor’s principals and interest, and at least $6.5 million on personal and family expenses. [2]

In its complaint, the SEC alleges that Sky Group and Betancourt’s fraudulent actions and omissions violated several provisions of the Securities Act of 1933 and the Exchange Act of 1934.

This case is of unique importance because Sky Group and Betancourt relied heavily on the insidious tactic of affinity fraud. At a base level, affinity fraud targets a specific, often tight-knit group of people who share something in common – here, a common nationality. Fraudsters then attempt to gain trust within the group and use that trust to financially exploit the group through their fraudulent investment scheme. [3]

The SEC has published an investor alert on the topic of affinity fraud, which urges investors to take the following steps to avoid falling prey to an affinity fraud scheme:

• Carefully research the background of any person who makes an investment offer, even if they seem trustworthy.
• Do not make investment decisions based solely on a recommendation from a member of a group you belong to.
• Be on the lookout for investments with unusually high or “guaranteed” returns – investments are rarely risk-free, and when an investment seems too good to be true, it often is. [3]

While this case is ongoing, our attorneys are available to guide you through any inquiries you might have related to affinity fraud or to this complaint.

Sources: [1] https://www.sec.gov/litigation/litreleases/2021/lr25234.htm [2] https://www.sec.gov/litigation/complaints/2021/comp25234.pdf [3] https://www.investor.gov/introduction-investing/general-resources/news-alerts/alerts-bulletins/investor-alerts/investor-60

The SEC’s order concerns a period of time from 2016 through 2019, during which the SEC alleged that respondents made material misrepresentations and omissions about their oil and gas securities offerings. [1] The order states that neither Powell nor Toth were registered nor even associated with a registered broker-dealer during the relevant time period as they sold unregistered securities to investors. [2]

RCP is described as a private equity firm that “gives smart investors access to beyond-Wall Street assets, such as oil and gas wells” by creating, and then offering, oil and gas debt and equity investment vehicles for oil and gas wells. [2] In so doing, RCP relies on Homebound to identify and purchase these oil and gas wells. [2] During the relevant time period, Thomas Powell owned RCP while Stefan Toth owned and managed Homebound. [2]

Some of the several material misrepresentations and omissions highlighted in the SEC’s order include:

• Circulating offerings materials which falsely stated that respondent’s oil and gas securities were sold by FINRA-member broker-dealers who were registered with the SEC.
• Publishing “one-pager” documents for investors that contained “insufficiently supported oil well production projections.” These projections did not vary by region and projected that three separate wells would produce 510 barrels/day while actual production at these wells landed at only 3-5 barrels/day.
• Failing to take reasonable steps to ensure that investors were accredited, resulting in the sale of unregistered securities to approximately 200 non-accredited investors
• Misleading retirement account investors by advertising the potential tax benefits of oil & gas investments without stating that these benefits were not available to retirement account investors. [2]

Although Powell and Toth neither admitted to nor denied the charges, they have each agreed to pay a civil penalty of $75,000. Homebound and RCP have each agreed to pay a civil penalty of $225,000. The respondents also face several other consequences as part of the settlement, including a two-year prohibition on participating in any unregistered oil and gas related offerings, and a requirement that the SEC’s order be linked on all of their websites for the next three years.

Respondents must also hire an “Independent Compliance Consultant” at their own expense to review their policies and procedures as they relate to federal securities law, as well as to certify that respondents are indeed in compliance with said policies and procedures prior to any offering of securities. [2]

These punitive measures are designed with investor protection and the public interest in mind, as the SEC aims to reduce the instance of similar violations not only by respondents, but also by other equity firms and broker-dealers in the United States. The order also serves as an important reminder for investors to partner closely with trusted professionals in making informed investment decisions, especially in a volatile market like oil and gas.

Sources: [1] https://www.sec.gov/news/press-release/2021-193?utm_medium=email&utm_source=govdelivery [2] https://www.sec.gov/litigation/admin/2021/33-10987.pdf

While this marks the SEC’s first enforcement action against an alternative data provider, it likely will not be its last, as the use of alternative data in the financial and investment sphere continues to rise. [2] Alternative data (“alt-data”) is data which goes beyond that of traditional corporate financial statements and helps guide investment strategies. [3] Examples of alt-data include mobile device data, credit card transactions, satellite imagery data, product reviews, and even social media activity. [4]

This type of data can be instrumental in making sound investment decisions when it is paired with traditional data from corporate sources, because it provides a broader view of a company’s financial viability. [4] However, it is notoriously difficult to aggregate and analyze given its vast breadth – it’s estimated that the world produces at least 2.5 quintillion bytes of such data daily. [4] This is where companies like App Annie come in.

App Annie, one of over 400 alt-data providers currently in operation, provides its customers with alt-data aggregation resources and insights. In particular, the company focuses on mobile app performance, providing its customers with estimates of app downloads, usage rates, and revenue generation for a given company. [1] These insights, in turn, help trading firms and customers make sound investment decisions. However, the SEC alleges, App Annie made material misrepresentations to its users, leading to the securities fraud charges at hand. [1]

In particular, the SEC alleges that App Annie committed violations of the anti-fraud provisions of Section 10(b) of the Exchange Act by assuring its customers that the financial data it sold was subject to an advanced statistical model in line with federal securities laws. On the contrary, the SEC posits that App Annie had no such statistical model in place, instead relying on “non-aggregated and non-anonymized” data to make its model-generated estimates appear more lucrative to trading firms.[1]

Because App Annie’s deceptive practices coincide with the purchase or sale of securities, the situation was ripe for SEC intervention. Furthermore, the SEC’s September 14^th statement notes that App Annie was well aware that they could only garner the confidential data they sought from customers by promising to keep it confidential; however, the data was not kept confidential as promised.

While App Annie, along with Bertrand Schmitt, settled with the SEC without admitting nor denying any of its allegations, this situation should serve as an eye-opener for firms and investors alike. When it comes to confidential, sensitive, data, it is critical to vet who has access. Even companies purporting to act in their customers best interest may have ulterior motives.

Considering the wealth of data points that most people produce every day, it’s critical to understand how companies may interact and analyze them. Just as important, society should also remain vigilant as to who is trusted with personal or sensitive data, and carefully vet alt-data providers to help guide investment decisions. For further insight or counsel, please reach out to one of our experienced attorneys here at Savage Villoch Law.

Sources: [1] https://www.sec.gov/news/press-release/2021-176 [2] https://www.datadriveninvestor.com/alternative-data/#The_Growth_of_Alternative_Data [3] https://builtin.com/fintech/alternative-data [4] https://amplyfi.com/2021/07/08/what-is-alternative-data/

Robert Jackson, a professor at NYU School of Law and former SEC Commissioner, and John Morley, a Yale Law School professor, recently filed three suits against high-profiles SPACs in New York federal court. The suits argue that each SPAC is operating as an unregistered investment company, and under the Investment Company Act of 1940 (the “Act”), compensation paid to the SPAC’s sponsors and directors was illegal and void under the Act. However, in the decades-long history of SPACs, these entities have never been classified as investment companies under the Act, nor has the SEC purported that they should.

At the center of this debate lie two secondary, though potentially even more important, questions: what is a SPAC, and what is a SPAC’s primary purpose? The answer to these questions determines whether SPACs should indeed be classified as investment companies under the Act, as Jackson and Morley contend, or whether SPACs may continue to operate independently of the Act, as the SPAC industry and a wide coalition of law firms believe.

A SPAC is a type of blank check company which operates with the aim of finding an existing company to merge with, thus taking that company public. Typically, a SPAC is founded by an institutional investor, or group of institutional investors, who raise capital to go public via a SPAC IPO. The SPAC’s sponsors typically must then find a company with which to merge within 18 to 24 months. While SPAC sponsors search for a merger target, investors’ dollars are typically placed in trust accounts which hold various securities. [1]

Because SPACs have no sales or operations of their own, investors face a considerable degree of risk when they choose to invest in a SPAC before a merger occurs. At the same time, the merging company reaps the benefit of bypassing rigorous and time-consuming financial disclosures which the traditional IPO process entails. Once a merger occurs, the company has automatically gone public.

Under the Investment Company Act of 1940, “an investment company that is or holds itself out as being engaged primarily, or proposes to engage primarily, in the business of investing, reinvesting, o trading in securities.” [2] Jackson and Morley argue that because SPACs invest the proceeds from their IPOs in trust accounts while they search for a target to merge with, most SPACs are just this – entities who engage primarily in investing in securities.

SPAC industry players, including the group of over 60 large law firms in the United States, contest this view. The law firms quickly signed onto a statement which refutes the factual and legal basis of the lawsuits, arguing that the primary business of a SPAC is that of identifying and acquiring a company within a specific period of time. [2]

Their argument centers on a plain text analysis of the Act’s language, and states that so long as a SPAC engages in its primary business of acquiring a company, their short-term investments in their trust accounts do not make them an investment company under the Act. [2]

While this public refutation from some of the country’s leading law firms is noteworthy, its impact on the three lawsuits filed is attenuated. It is also important to note that some of these firms represent and receive earnings from SPAC dealings themselves. [1]

The outcome of each of these anti-SPAC cases will be interesting to track, particularly considering their potential impacts on the SPAC industry. One expert maintains that if a court were to determine that SPACs are investment companies subject to the Act, the decision would “wreak havoc in the industry, forcing sponsors to restructure their compensation and find new ways to safeguard investors’ capital.” [3] As these cases progress, please reach out to our attorneys with any questions you might have.

[1] https://www.reuters.com/legal/litigation/49-firms-72-hours-how-spac-bar-united-against-law-profs-splashy-lawsuits-2021-08-30/\

[2] https://www.jdsupra.com/legalnews/over-55-of-the-nation-s-leading-law-4944524/

[3] https://www.reuters.com/legal/litigation/49-firms-72-hours-how-spac-bar-united-against-law-profs-splashy-lawsuits-2021-08-30/

While these regulatory agencies have identified multiple concerning fraudulent schemes, each type is centered around impersonation of investment advisers – a particularly worrisome and dangerous trend. A recent example was reported by the Texas State Securities Board, which announced that a Texas fraudster created a website for Prestige Assets Mgnt LLC, a name which is almost identical to that of the registered investment adviser Prestige Asset Management LLC. [1]

The regulator alleges that while the website is phony and does not represent a licensed dealer or investment adviser, it was built to look authentic, and actually directed users to the registered firm’s office location and CRD number. [1]

According to the SEC, scams to be on the lookout for include not only “spoofed websites” like this one, but also fake social media profiles soliciting investments directly from users, as well as cold calls aided by technologies that trick victims into thinking the call is coming from a licensed firm. [2]

These scams all operate by posing as a licensed investment adviser or firm, only to solicit and steal sensitive customer data and ultimately, money. While these schemes are dangerous to anyone who unknowingly comes across them, they often pose a distinct danger to those who are less technologically inclined or do not take sufficient care to validate a firm or adviser’s credentials. Of course, fraudsters take careful steps to impersonate advisers, which makes investor vigilance even more critical.

So, what are the best ways to protect yourself and your wallet?

Awareness is a great place to start. Being armed with the knowledge that fraudsters are increasingly posing as licensed investment advisers can go a long way as you choose an adviser. Along with this awareness, paying close attention to potential red flags is also prudent.

Prominent red flags that may point to a fraudulent scheme include the guarantee of high investment returns, unsolicited offers from unknown senders, and requirements to make payments with either credit cards or cryptocurrencies. Typically, a licensed and registered investment firm will not accept investments via credit cards, nor will they require the use of a cryptocurrency or other digital asset wallets. [2]

In addition, if payment is conducted through a wire transfer or check, investors should always confirm that payment is not being sent to someone other than the firm, and that the address is indeed an office building or other reasonable location in which the firm could operate. [2]

Advisers themselves can also help protect investors from fraudsters by periodically checking that they are not being impersonated online or otherwise. Tactics like google image searches for company logos and google alerts to notify when an adviser’s name or other business information is used without authorization can be pivotal in identifying fraudsters. [2] If an adviser notices potential impersonation, they can report the concerns to FINRA BrokerCheck, as well as to the SEC or securities regulator in their state.

Finally, as a general rule, a broker or investment adviser should be registered with the SEC or a state regulator before they are licensed to give advice to retail investors. Prospective investors can verify that their investment adviser is currently licensed by using the search tool available on Investor.gov. It’s also prudent to contact the adviser through a second means not provided directly by them, to verify they are indeed who they say they are. [1]

Both awareness of these scams and alertness to potential red flags can help protect your money as an investor, or your business reputation as an adviser. If you have any questions or believe you may have been impacted by a scam like these, please reach out to us.

Sources: [1] https://www.barrons.com/advisor/articles/fraud-impersonating-advisors-protect-data-51628797073?st=hc56ha5ls4gyhvn [2] https://www.sec.gov/oiea/investor-alerts-and-bulletins/fraudsters-posing-brokers-or-investment-advisers-investor-alert

The PRI is an independent network of investors who promote responsible and sustainable investing by incorporating ESG factors and considerations into their investment decisions. Although the PRI is not a part of the UN itself, the UN supports and partners with the group. In 2006, when the PRI was formed, it managed about $7 Trillion in assets, and in 2020, it managed over $100 Trillion. [1]

So why should you as an investor care about ESG investing? ESG factors and criteria empower investors to make “socially responsible” and sustainable investment decisions by providing important insight into a company’s operations, standard practices, and culture through the lens of Environmental, Social, and Governance considerations.

For example, a company might disclose Environmental factors such as their carbon emissions or water usage, aimed at conserving our natural world. Social factors place an emphasis on how a company treats both its employees and the public and include employee diversity statistics or human rights considerations. Finally, Governance factors focus on the way in which the company is led and include information like executive pay scales as well as political leanings. [2]

When an investor is equipped with meaningful – and truthful – ESG information, they can be confident in their monetary support of a company. As a result, ESG investing continues to be top of mind for investors and regulators in the United States. However, investor interest is not the only factor influencing ESG popularity. Sound ESG investing also yields relatively high returns when compared to conventional funds while providing relatively lower risk, according to a study by Morgan Stanley in 2019. [2]

While many companies voluntarily disclose ESG data, there is currently a gap in investor knowledge, as many ESG disclosures are not yet compulsory. One particular area in which this is true is with regard to climate change disclosures – which the SEC published guidance on in 2010 but have not been adjusted since then.

At Wednesday’s PRI event, Commissioner Gensler focused in on the value and importance of climate change disclosures and provided a glimpse into the future of SEC regulation of the topic. In particular, Gensler emphasized that these disclosures must be “decision useful,” meaning that they include sufficient factual information to allow proper decision-making to take place.

Gensler also highlighted the intense interest modern investors have in the climate risks associated with stocks they purchase, likening the investor push for climate risk disclosure today to the push for disclosure of basic financial information decades ago. In response to this investor interest, Gensler announced that he has tasked his staff with developing a proposal for mandatory climate risk disclosures for review by the end of 2021. [3]

The transition from the SEC’s current climate risk guidance to mandatory SEC climate risk disclosures is monumental, and it will allow investors to compare “apples to apples” when analyzing climate risk data between companies.

Furthermore, Commissioner Gensler spoke about the possibility of requiring disclosure of carbon emissions data not only for the company itself, but for each member of the company’s value chain. Granular data like this will provide investors with a truly actionable and “decision useful” basis for making investment decisions by providing not just a piece of the puzzle, but instead the full picture of a company’s true impact on the environment.

As we enter the back half of 2021, investors should be on the lookout for additional remarks by Commissioner Gensler relating to climate risks and ESG disclosures. While we have only a blueprint now, support and demonstrated investor interest in ESG factors will encourage the SEC to continue its pursuit of meaningful regulation to benefit investors like you.

Sources:

[1] https://www.unpri.org/pri/about-the-pri

[2] https://www.nerdwallet.com/article/investing/esg-investing

[3] https://www.sec.gov/news/speech/gensler-pri-2021-07-28

FINRA noted three major violations from its investigation into Robinhood’s conduct and operations as a stock-trading app, each of which merited its own penalties.

First, FINRA found that Robinhood has pervasively and negligently provided false or misleading information to its customers. [1] This false information was circulated in spite of Robinhood’s core mission to “de-mystify finance for all” and “democratize finance,” and ranged from misrepresenting customer account balances and buying power, to erroneous communication about customers facing margin calls. [2]

As a result of Robinhood’s misrepresentations, FINRA is requiring the firm to pay over $7 Million in restitution to customers who suffered related losses. [1]

Second, FINRA found that Robinhood did not exercise proper due diligence in its options trading offerings. [1] Given the financially risky character of options trading, Robinhood improperly outsourced an algorithm powered by artificial intelligence to determine customer options trading eligibility. The technology was riddled with inconsistencies, causing eligibility decisions to be made based upon incorrect customer information, and allowing ineligible customers to engage in options trading. [1]

Finally, FINRA also uncovered issues with Robinhood’s technological supervision of its core business tenets. For example, Robinhood experienced a widespread outage of its platform in early March 2020, during which operations halted. Robinhood customers were unable to access their accounts for a period of two days, during which market volatility was incredibly high. This outage, which was only one of many similar situations, resulted in approximately $5 Million in customer losses, which Robinhood has now been ordered to pay in restitution. [1]

Beyond these three severe offenses, FINRA also found that Robinhood has violated several other rules as a brokerage firm in recent years. Robinhood has failed to report failures and customer complaints which are required by FINRA, and has also failed to show customers complete market data as they make sensitive decisions about securities trading.

Robinhood, for its part, responded to the charges by stating that they are actively improving their educational resources, customer support capabilities, and legal and compliance teams. [2] They are “glad to put his matter behind [them]” with a renewed focus on the continued democratization of finance for all. [2]

FINRA’s message through these sanctions is clear – violate brokerage industry rules, pay the price. Its Head of Enforcement, Jessica Hopper, added that “all FINRA member firms, regardless of their size or business model, must comply with the rules that govern the brokerage industry . . . to protect investors and the integrity of our markets.” [1][2]

Given Robinhood’s exploding popularity among retail investors, particularly during the pandemic, this settlement should be a reassuring sign to investors that FINRA is taking its duty to protect their interests seriously. On the same token, customers of platforms like Robinhood should remain diligent in their financial decisions and report any potential issues for assessment by either the firm or by FINRA itself.

Sources: [1] https://www.finra.org/media-center/newsreleases/2021/finra-orders-record-financial-penalties-against-robinhood-financial [2] https://www.cbsnews.com/news/robinhood-finra-70-million-fine/