1. Misalignment of Interests: While RIAs are held to a fiduciary standard by the Investment Advisers Act of 1940, this does not entirely eliminate the risk of self-interest affecting an RIA’s advice. For instance, RIAs might favor only those investment products from firms that are paying significant commissions to the RIA for selling that product. This means there is a significant potential conflict of interest causing an RIA to recommend the same small set of investment products to every potential client.
2. Limited Product Offering: Many RIAs have a limited range of investment products due to affiliations with certain investment companies. This could mean you may not have access to the full spectrum of investment options that might be more suitable for your retirement needs.
3. Lack of Transparency: Even though RIAs are required to disclose all material facts to their clients, the complexity of the investment products such as annuities and life insurance products may result in you not fully understanding certain investments, the adviser’s commission for selling a specific product, or the risks involved in an investment strategy recommended by the RIA.
4. Qualifications and Experience: RIA’s expertise and experience can vary significantly. While some have extensive experience and hold multiple qualifications, others might be newer to the industry and less experienced. A less qualified RIA might not provide the best advice or understand the intricacies of complex investment strategies. Further, it is important to check your adviser at brokercheck.org and investigate their history. There are plenty of RIAs who are and RIA because they are unable to be a stockbroker (yes, there is a huge difference.)
5. Costs: RIAs usually charge a fee based on a percentage of assets under management, which might be higher than what you’d pay if you managed your investments independently or did not invest in annuities or life insurance products. Additionally, some RIAs may have hidden costs or might charge additional fees for specific services on top of the percentage fees they charge.
6. Poor Communication: In some cases, you might find that your RIA does not communicate effectively or regularly. This could leave you feeling uninformed about your investment decisions and progress toward your retirement goals.
7. Inadequate Personalization: Some RIAs might use a one-size-fits-all approach to investment strategies, which could result in your retirement assets not being fully able to meet your specific goals, risk tolerance, and timeline to, or in, retirement.
8. Limited Accessibility: Depending on the RIA, you may face issues regarding the accessibility of your adviser. If they manage a large number of clients, they might not be available when you need them, impacting your ability to make timely decisions. This applies to the investment products that RIAs may recommend to you because the investment products often have significant penalties for early ‘surrender’ and withdrawals, or even have no option to gain access to your money.
9. Risk Management: Not all RIAs are skilled in managing risk effectively. A failure to appropriately assess and mitigate risk could potentially result in substantial losses for your retirement portfolio.
10. Lack of Oversight: While RIAs are regulated by either the Securities and Exchange Commission (SEC) or state regulators, this does not guarantee that your investments are safe. If the oversight body does not effectively regulate the RIA’s practices, your retirement assets could be at risk. Another oversight issue is that many RIA’s have no insurance to provide coverage to you for the RIA’s potential negligent or fraudulent handling of your account.

Despite these potential problems, it’s important to remember that many RIAs provide excellent service and can significantly contribute to the growth and protection of your retirement assets. The key is doing your due diligence in selecting an adviser. Check their qualifications, regulatory records, and references. Understand their fees, services offered and their investment philosophy. Good communication is essential, so ensure you feel comfortable discussing your needs and goals with them. Finally, always remember that it’s your retirement – stay informed and involved in the management of your assets.

Retirement planning can be a complex process, but knowing the potential pitfalls of entrusting your retirement assets to an RIA can help you make an informed decision that aligns with your retirement goals and financial situation.

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.

More information on the first three of these tactics – the “phantom riches” tactic, the “social consensus” tactic, and the “credibility” tactic – and how investors can avoid them can be found in Part One of this two-part series.

Here, we will consider the remaining two most common investment fraud tactics identified by FINRA and the SEC: the “reciprocity” tactic and the “scarcity” tactic.

The Reciprocity Tactic

Under the reciprocity tactic, supposed investment professionals will lead investors to believe that if the investor participates in the investment opportunity at hand, they will receive an outsized benefit relative to what they put in, while the investment professional purports to take some sort of a hit. [1]

In the real world this tactic can look like a fraudster offering an investor half off on a given investment opportunity, along with a break on usual commission, so long as the investor buys in immediately. [1]

Like many common investment fraud tactics, the reciprocity tactic is yet another example of an investment opportunity that appears too good to be true. The supposed investment professional or stockbroker puts pressure on the investor by offering what looks to be a great deal in exchange for the investor’s immediate buy-in, depriving the investor the critical chance to investigate and confirm the credibility of either the professional or the investment opportunity.

The best way to avoid falling prey to such a scheme is for investors to understand that authentic investment opportunities will not be sold using coercive tactics such as this one. Investors should never make an investment decision before taking the opportunity to fully vet the professional offering the opportunity and the opportunity itself.

The Scarcity Tactic

Similarly, the scarcity tactic also unduly coerces investors into taking immediate action with their dollars so as to “take advantage” of a seemingly can’t-miss investment opportunity. In reality, when this tactic is offered, investors should only expect to lose money, not gain.

When fraudsters employ this tactic, they convince prospective investors that if they do not buy into the investment opportunity immediately or very soon, the remaining units will be taken up by other, competing, investors. [1]

Investors should be on the lookout for communications implying that there are only a small, finite, number of units left to invest in, and that these units are going fast. [1] Any implication that the investment is scarce should alert investors to exercise heightened due diligence in determining whether the investment opportunity is legitimate.

Unfortunately, tactics employed by investment fraudsters continue to improve and shift over time. Luckily, investors can be their own first line of defense. With the help of online resources to validate the licensing status of investment professionals and investment opportunities, along with an understanding of the most common tactics and red flags to be aware of, investors can avoid falling prey to investment fraud.

Source:

[1] https://www.finra.org/investors/protect-your-money/avoid-fraud

Per the Financial Industry Regulatory Authority (FINRA) and the Securities and Exchange Commission (SEC), three of the most common investment fraud tactics employed by scammers in the United States are known as the “phantom riches” tactic, the “source credibility” tactic, and the “social consensus” tactic. [1]

Each tactic essentially functions by allowing the fraudster to build a false narrative surrounding their supposed investment opportunity, thereby garnering interest and ultimately investment dollars from unsuspecting investor victims.

The Phantom Riches Tactic

The “phantom riches” tactic involves enticing investors with the prospect of gaining an unattainable increase in wealth. [1] An example of this tactic in practice would be a fraudster telling a prospective investor “most of our investors are making $8-9,000 a month off this deal.” [2]

This tactic works by offering investors an opportunity they feel is simply too good to pass up. When fraudsters use the phantom riches tactic, they are lying about the investment opportunity so as to trick investors not into thinking the opportunity is too good to be true, but instead that the opportunity is too good to turn down.

Often, the fraudster also makes the alleged opportunity appear exceedingly easy for investors to become involved with. Prospective investors are led to believe not only that if they participate, their investment will earn them outstanding returns, but also that the investment opportunity requires almost no effort on the investor’s part.

In reality, the fraudster has fabricated the investment opportunity, and their promise of high returns will instead materialize as considerable losses to the investor.

The Source Credibility Tactic

When employing the source credibility tactic, fraudsters also engage in deceit, this time about their true identity and professional credentials. By communicating to the world that the fraudster is a graduate of a well-respected academic institution or has relevant professional experience and/or professional certifications and licenses, the fraudster places themselves in a respected societal position, albeit a patently fake one. [2]

Operating from this supposedly elevated social and professional tier, fraudsters have a much easier time convincing investors to fork over their money, and eventually lose it for good. While this tactic can be challenging to navigate, given the false impressions the fraudster is setting forth, there are many resources available online which prospective investors can use to confirm the identity and licenses actually earned by the purported professional.

The Social Consensus Tactic

Finally, the social consensus tactic involves stirring up investor interest in a scam by falsely stating that “everyone” or certain members of a group have already joined, and that those who have joined are making a great amount of money. [2] In reality, it is unlikely that many members of a group have joined the scheme – yet the mention of the community interest results in a greater sense of trust in the fraudster.

These tactics are just the first three of five main tactics that the SEC and FINRA warn investors to be aware of. Next week, this blog will cover the remaining two most common tactics used by investment fraudsters.

Remember that the first step in protecting assets is knowing the risks, like fraud, which they entail.

Sources: [1] https://www.finra.org/investors/protect-your-money/avoid-fraud [2] https://www.sec.gov/investor/seniors/outsmarting.pdf

Yet there is one investment risk – the risk of fraud – which at first glance seems uniquely difficult to mitigate. Fortunately, there are indeed several steps investors can take to protect their hard earned investment dollars from fraud.

In the United States, the Securities and Exchange Commission (“SEC”) and the Financial Industry Regulatory Authority (“FINRA”) each offer investor resources for reducing the risk of investment fraud.

FINRA advises investors to follow three specific steps to avoid fraudulent schemes: staying informed about ongoing scams, thoroughly vetting the background of any investment opportunity or professional an investor chooses to engage with and keeping current with common tactics employed by fraudsters. [1]

Stay Informed With Investor Alerts

Importantly, both the SEC and FINRA issue periodic “investor alerts” which explain recent fraudulent investment schemes toward which investors should exercise caution. Investor alerts from the SEC can be found here, and investor alerts from FINRA can be found here. Vet the Investment Opportunity

investors should also thoroughly vet the background and credentials of any investment opportunity or professional they choose to engage with [1]

When it comes to vetting the background of investment professionals, FINRA first recommends directly asking whether the individual is licensed to sell the investment. [2] FINRA and the SEC also both offer online resources to help confirm whether the professional is indeed registered as required under law. [2]

These resources include repositories listing the financial professionals who are registered with federal and/or state agencies, as well as resources which indicate whether the individual has engaged in known fraudulent acts in the past. [2] Investors can also use these resources to determine whether the investment they are considering is registered with the SEC. A one-stop shop for each of these free resources can be found here. Keep Up to Date on Common Fraudulent Tactics

Finally, a third helpful strategy for keeping hard earned investment dollars safes is staying aware of common investment fraud schemes along with “red flags” that often signal fraudulent activity.

Investors should always keep in mind that if an investment opportunity seems “too good to be true,” then it likely is.

In particular, common red flags to be on the lookout for include mentions of guaranteed or overly consistent returns, particularly complex investment strategies, and “pushy” salespeople. [3] Often, fraudsters will employ high-pressure sales tactics to present supposed investment opportunities as exciting ways to make large sums of money with comparably little effort required from the investor. [3]

Investors should also keep in mind that many investments are inherently risky. If a supposed investment professional advertises a new investment opportunity with no risk at all, or if any other red flags arise, it is likely time to dig deeper into the specifics of the investment opportunity.

Exercising careful attention to both the supposed processional and the investment they are offering is often the best strategy to protect investments avoid falling victim to a fraudulent investment scheme.

Sources: [1] https://www.finra.org/investors/protect-your-money [2] https://www.finra.org/investors/protect-your-money/ask-and-check [3] https://www.finra.org/investors/protect-your-money/avoid-fraud/red-flags-fraud

The SEC’s complaint charged Justin Costello with violations of the anti-fraud provisions of several federal securities laws as a result of his role in this massive fraudulent scheme. [2]

While the SEC’s complaint alleges a broad web of fraudulent investment schemes, Costello mainly operated through deceit about his background, his qualifications, and the value of the companies he owned and operated. [2] Throughout the span of his fraudulent schemes, Costello was never registered with the SEC as a broker-dealer nor investment adviser. [2]

Costello’s success in bringing in clients largely rested on his fabricated credentials. Costello falsely stated to both the public in a press release and to the SEC in a Form 8-K filing that he graduated from the University of Minnesota and the Harvard Business School. In reality, Costello graduated from neither of these schools, but instead from Winona State University. [2]

Costello also alleged to prospective and existing clients that he was “the youngest hedge fund billionaire ever,” that he was a veteran of the United States Special Forces, and that he was licensed in money and investment management. [2] Each of these assertions was false yet helped to build Costello’s reputation and lure in unsuspecting clients. [2]

Once Costello secured advisory clients, he operated his fraudulent scheme by exercising complete and independent control over their brokerage account investments to invest only in securities of companies he owned.

In one case, Costello instructed a client never to log into their brokerage account while he managed it. While Costello managed all of the trades in the account, he advised the client that should the client’s brokerage firm ever reach out, the client should lie and state that the client had made the trades, not Costello [2]

Eventually, the client’s initial brokerage firm terminated its business with the client. Costello then convinced the client to allow him to manage another $1.27 million in a new brokerage account with a different brokerage firm, maintaining the same level of unfettered control. [2]

Costello’s independent control over the client’s brokerage accounts played directly into his fraudulent scheme. While he told the client that he would invest in a diversified portfolio of securities, Costello instead invested and traded only in microcap companies owned by him or in which he personally invested, presenting serious insider trading implications.

Costello began managing these brokerage accounts in 2019, and by 2022, the millions of dollars he was originally trusted to manage had dwindled downward by approximately 97% as a result of his fraudulent insider trading scheme. [1]

This is but one of several simultaneous fraudulent schemes Costello ran between 2019 and 2020. The SEC is seeking injunctions, disgorgement, civil penalties, and a prohibition against Costello ever serving as a broker dealer in the future. [2]

Protecting yourself from a fraudulent stockbroker may seem daunting, but the SEC’s Office of Investor Education and Advocacy publishes free resources on Investor.gov to help conduct reviews of a broker-dealer’s background before engaging in business.

Furthermore, if you think your stockbroker may have misrepresented their qualifications, license, or has engaged in fraudulent investment practices, the attorneys at Savage Villoch law can assist you – reach out for your consultation today.

Sources:

[1] https://www.sec.gov/news/press-release/2022-178

[2] https://www.sec.gov/litigation/complaints/2022/comp-pr2022-178.pdf

Per the SEC’s September 29, 2022 complaint, Bradley Goodbred, a registered investment adviser based in Illinois, misappropriated a total of $1,295,000 from a 97-year-old client between 2012 and 2021. [1] While the defendant, Goodbred, returned a portion of this money, his client still lost more than half a million dollars as a result of his fraudulent actions. [2]

According to the SEC’s complaint, Goodbred became the client’s investment adviser sometime before 2006, when the client and her husband were searching for a trusted, long-term financial adviser to help guide financial decisions in the event that the client’s husband passed away. [1]

After the client’s husband’s death in 2006, Goodbred became a “friend and confidant” to the client, who had no next-of-kin and who lived by herself. [1] By 2013, Goodbred had been appointed as the investment adviser for the client’s trust account and as power of attorney for purposes of the client’s health and property. [1]

As an adviser, and with a substantial amount of power over the client’s health and finances, Goodbred owed fiduciary duties to the client including the duty to act in her best interest and the duty to act towards her in good faith. [1]

The SEC alleges that Goodbred violated these duties when he misappropriated large sums of the client’s financial resources. Goodbred committed these fraudulent acts by soliciting the client to transfer more than $1 million from 2012 to 2021 to a business he owned. [1] Goodbred then purported to invest the client’s funds in real estate investment trusts (“REITs”) on the client’s behalf. [1]

In reality, Goodbred did not invest any of the client’s money in REITs on her behalf. [1] He instead used the money to cover personal and business expenses which bore no relation to the purported investments. [1] These expenses included income taxes, automobile loans, and credit card debt incurred by Goodbred and his wife. [1]

Today, the client suffers from dementia and is cared for by a court-appointed guardian. [1] Goodbred’s fraudulent scheme was only uncovered when the financial institution he worked for received a complaint suggesting that Goodbred was “exercising inappropriate discretion over the Client’s trust account,” for which an investigation was launched. [1]

The investigation resulted in Goodbred’s firing from the financial institution, and ultimately these charges by the SEC. [1]

Through its complaint, the SEC alleges 5 counts of federal securities fraud and seeks injunctions against Goodbred and appropriate civil penalties, ultimately to be determined via a jury trial. [1]

This case indicates the dangers posed by financial advisers who obtain undue power over their client’s financial resources and ultimately use it for their own betterment. Here, the client and her husband believed they had hired a trustworthy financial adviser to guide them as they both advanced in age. Instead, they became victims of more than $1 million in theft.

All investment advisers should be thoroughly vetted, and clients should do all they can to monitor the activity of their advisers, or otherwise appoint a neutral third party without direct power over the finances to assist in monitoring.

If you think you have been taken advantage of by your financial or investment adviser, the trusted attorneys at Savage Villoch law are ready to help. Reach out for your consultation today!

Sources:

[1] https://www.sec.gov/litigation/complaints/2022/comp25536.pdf

[2] https://www.sec.gov/litigation/litreleases/2022/lr25536.htm?utm_medium=email&utm_source=govdelivery

On September 20, 2022, the SEC fined financial services giant Morgan Stanley Smith Barney (“MSSB”) $35 million for failing to adequately protect its customer’s records and personal identifying information (“PII”). [1] The fine was entered via a settlement between the SEC and MSSB, through which MSSB has agreed to pay a civil penalty for the SEC’s charges without admitting to nor denying the violations. [2]

MSSB is a subsidiary of Morgan Stanley and focuses on wealth management services for clients ranging from individuals to large corporations. [3] More specifically, MSSB is the broker-dealer designation for the group more commonly known as Morgan Stanley Wealth Management. [3] During the second quarter of 2022, Morgan Stanley Wealth Management recorded $5.7 billion in net revenues. [4]

Through its order, the SEC alleged that MSSB engaged in two separate violations of federal securities laws. First, the order alleged that MSSB willfully violated the Safeguards Rule, a federal regulation which requires broker-dealers to adopt written policies and procedures regarding safeguards for the protection of customer data. [1]

Second, the order alleged MSSB’s willful violation of the Disposal Rule, a federal regulation requiring broker-dealers which possess consumer data to “take reasonable measures to protect against unauthorized access to, or use of, the information in connection with its disposal.” [1]

MSSB’s alleged violations occurred in connection with its effort in 2016 to decommission two data centers (the “2016 Data Center Decommissioning”). [1] To accomplish the decommissioning process, MSSB contracted with one approved vendor, referred to as “Moving Company,” to “pick-up, transport and decommission” devices from the MSSB data centers. [1] While Moving Company was one of MSSB’s approved vendors, MSSB never approved any sub-vendors for the decommissioning process. [1]

Despite this fact, Moving Company worked jointly over the course of the decommissioning process with two separate, unapproved sub-vendors – “IT Corp A” and “IT Corp B.” [1] Initially, Moving Company collected devices from the data centers and delivered them to IT Corp A. IT Corp A would either complete the required data-wiping processes and resell the devices, or destroy the devices altogether. [1] Inventories were kept, and MSSB received information about the wiped and destroyed devices from Moving Company. [1]

Not long after the decommissioning began, however, Moving Company ceased working with IT Corp A in favor of IT Corp B. Per the SEC’s findings, Moving Company sold the MSSB devices to IT Corp B under the guise that the devices had already been wiped of any MSSB data. In reality, the devices had not been wiped, yet IT Corp B gained possession of the devices and began selling them to downstream customers. [1]

MSSB became aware of this data breach when an IT consultant from Oklahoma emailed MSSB to inform them that it had purchased hard drives via an online auction, and that the hard drives contained accessible MSSB customer data. [1]

In all, the SEC’s order seeks to hold MSSB accountable for its failure to properly safeguard the sensitive data its customers entrust it with. Per the SEC’s findings, MSSB failed to adequately vet the data wiping and destruction processes of its approved vendor, Moving Company, and further failed to maintain its own internal policies and procedures to ensure customer data is disposed of properly. [1]

This situation serves as a cautionary tale. While MSSB contends that it has received no reports of customer data being misused as a result of this breach, the company still clearly has room for improvement in maintaining the security of its customer data. No matter the size of the broker, investors should be wary of the safety of their personal data.

Have concerns about a breach of your personal data? Reach out to one of the trusted attorneys at Savage-Villoch Law for a consultation.

Sources:

[1] https://www.sec.gov/litigation/admin/2022/34-95832.pdf

[2] https://www.sec.gov/news/press-release/2022-168

[3] https://www.morganstanley.com/content/dam/msdotcom/en/about-us-ir/shareholder/2q2022.pdf

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

The eleven defendants include Forsage’s four founders as well as several “promoters” of the Forsage scheme. [2] The SEC’s complaint notes that to date, more than $300 million worth of transactions have occurred via Forsage smart contracts, despite the fact that the retail investors powering this scheme have received no good or service of value in return for their “investments.” [2]

Forsage is a classic pyramid scheme in that those at the top – namely the founders and promoters charged by the SEC – stood to gain the most wealth, especially as others joined the scheme after them. In fact, a recent scholarly report on the scheme found that more than 88% of Forsage users incurred net losses on their investments with the platform, with those at the top generating massive gains. [3]

While Forsage was promoted as an “income-generating opportunity” with impressive returns, the SEC alleges that the founders and promoters were well aware that their monetary gains were far higher than, and would be unattainable to, the retail investors they recruited. [2]

The Forsage scheme functioned exactly like a pyramid and Ponzi scheme, as wealth was almost exclusively generated through recruitment of additional “investors.” When an investor joined Forsage, the first step was to create a crypto-asset wallet, which was assigned a sequential Forsage ID. [2] The higher the Forsage ID, the later the investor had joined the scheme, and in turn, the lower returns an investor could actually expect to generate. [2]

Once an investor created their crypto-asset wallet, they could begin purchasing “slots” within Forsage’s smart contracts. [2] The purchase of a slot did not allocate any good or service of value to the investor. Instead, each slot purchased broadened the investor’s compensation earned from both new Forsage recruits and from existing members of the Forsage community. [2]

Upon purchasing a slot, the algorithm-based Forsage smart contracts would automatically direct crypto funds to the investor’s crypto-asset wallet whenever the investor recruited additional investors to join the scheme. [2] The smart contracts also automatically directed shares of funds from the broader Forsage community as a form of profit-sharing. [2]

A Forsage investor could not join the scheme without sending currency, in the form of Ether, over the platform. [3] In line with the structure of the Forsage smart contract code, currency sent by a new investor was automatically sent first to existing investors with lower Forsage IDs, thereby allowing those who had joined earliest to obtain the highest returns. [3]

The SEC’s complaint categorizes the slots within Forsage’s smart contracts as investment contracts which constituted securities. [2] These securities were not registered with the SEC. [2] As a result, the SEC alleges several violations of federal securities law, concluding that the founders and promoters were engaged in the unauthorized offer or sale of securities. [2]

This type of scheme is especially dangerous to unwitting investors because of the relative novelty of the cryptocurrency sector, along with the inability of law enforcement authorities to intervene and halt a scheme which is hosted over the decentralized blockchain. [4]

Additionally, hosting a scheme like this one over the blockchain affords the organizers the luxury of anonymity, something that would not be possible for organizers of a traditional pyramid or Ponzi scheme. [4]

Investors are urged to carefully evaluate their investment prospects to avoid falling prey to a cryptocurrency pyramid or Ponzi scheme like Forsage. While tales of high returns can be tempting, these schemes are specifically designed to trick investors into believing they will see returns that they won’t, while instead buffering the wallets of those who “invested” before them.

If you have questions or concerns about a potential cryptocurrency pyramid or Ponzi scheme, please reach out to the trusted attorneys at Savage Villoch law.

Sources: [1] https://www.sec.gov/news/press-release/2022-134 [2] https://www.sec.gov/litigation/complaints/2022/comp-pr2022-134.pdf [3] https://arxiv.org/pdf/2105.04380.pdf [4] https://www.coindesk.com/layer2/2022/08/08/how-to-stop-forsage-meta-force-and-other-smart-contract-pyramid-schemes/

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/

The win comes as a newly formulated legal theory offered by the SEC survived a motion to dismiss in SEC v. Panuwat, a case proceeding in the U.S. District Court for the Northern District of California.[1] The SEC’s legal theory states that the practice of “shadow trading” constitutes a violation of federal securities law, namely Section 10(b) of the Exchange Act and Rule 10b-5.[1]

“Shadow trading” occurs when a person with a connection to one publicly held company uses material, nonpublic information (MNPI) they have gained from their connection with that company to inform their trading decisions in a separate publicly held company. Typically, this separate company is economically connected in some way to the company for which the person possesses MNPI. [2]

In SEC v. Panuwat, the SEC alleged that the defendant, Panuwat, engaged in an instance of shadow trading which constituted illegal insider trading under 10b-5. At the time of the alleged shadow trading, Panuwat was Senior Director of Business Development at Medivation, Inc., where he reported directly to the company’s Chief Financial Officer. Medivation Inc. was a “publicly-traded, mid-cap, oncology-focused” corporation in the biopharmaceutical industry. [3]

On August 18^th, 2016, Panuwat received a confidential email from Medivation’s CEO stating that plans were being finalized for Meidvation’s acquisition by Pfizer, Inc. [3] Within minutes of receiving this confidential news, and on his work computer, Panuwat purchased shares in Incyte, one of Meidvation’s peers in the biopharmaceutical sector. [3]

When news of Pfizer’s acquisition of Medivation was released to the public just four days later, Incyte’s stock price rose appreciably, as did the stock prices of other industry peers.[3] As a result of Panuwat’s August 18^th trades, Panuwat generated gains in excess of $100,000.[3]

In SEC v. Panuwat, the SEC argues that Panuwat’s profits in this situation constitute “ill-gotten gains” in violation of federal insider trading laws because Panuwat based his purchase of Incyte shares on the material, nonpublic information he had received about Medivation’s impending acquisition by Pfizer. [3]

Panuwat moved to dismiss the SEC’s claims on the grounds that the SEC had not adequately pled that the information he received about the impending acquisition was material and nonpublic, that he breached his duty to Medivation; and that he acted with the requisite scienter. [1]

The court rejected each of these arguments and ultimately stated that the federal securities laws in question are indeed broad enough to permit MNPI from one company to be considered material in relation a separate company’s as well. This broad interpretation of Section 10(b) of the Exchange Act opens the door for the SEC’s argument that such “shadow trading” may indeed constitute actionable insider trading under federal law.

The court’s denial of Panuwat’s motion to dismiss, as well as their decision on the remainder of this case, will be of keen importance for public corporations and employees alike. Corporations may well begin considering revisions to the language of their internal insider trading guidelines to include explicit prohibitions on shadow trading.

Furthermore, individuals may need more carefully evaluate the basis on which they are making trades in the market, ensuring their trades are not motivated by material, nonpublic information that might also apply to a company besides the one they are directly connected to.

As SEC v. Panuwat unfolds, those interested in learning more about its implications may reach out to the attorneys at Savage Villoch with questions.

Sources: [1] https://www.troutman.com/insights/secs-new-insider-shadow-trading-theory-survives-its-first-test.html#_ftn1 [2] https://www.troutman.com/insights/securities-and-exchange-commission-tests-new-insider-trading-theory.html [3] https://www.sec.gov/litigation/complaints/2021/comp-pr2021-155.pdf

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

According to the alert provided by the SEC’s Office of Investor Education and Advocacy (“OIEA”), the SEC has received reports of several individuals receiving communications from people posing as SEC personnel. Whether these communications come in the form of emails, phone calls, or letters, the SEC warns investors that they are “in no way connected to the SEC.” [1]

The fraudulent phone and voicemail messages are particularly misleading because they come from phone numbers that appear to be connected to the SEC. [1] The communications have targeted victims by raising investment-related concerns, such as “suspicious activity” in both checking and cryptocurrency accounts.[1]

In raising these false concerns, the fraudulent callers solicit personal information as well as payments for alleged SEC enforcement actions. In some cases, the fraudsters may even impersonate a particular SEC employee in an effort to gain trust from their victims. As such, the OIEA urges investors to independently verify the identity of anyone claiming to be an SEC or other government employee. [1]

The alert also offers several ways to verify whether a communication is actually coming from an SEC employee. First, you can check with the SEC’s personnel locator in order to get in direct contact with the staff member who purportedly reached out from the SEC. The phone number is (202) 551-6000, which can be used to speak directly with SEC staff members to confirm whether they contacted you. [1]

In addition, concerned investors can also call (800) SEC-0330 or email help@SEC.gov to verify whether a communication truly came from the SEC. It is critically important to verify using one of these methods before providing personal information or any form of payment in response to an unsolicited communication claiming to come from the SEC. [1]

In responding to this impersonation scheme, the SEC also unequivocally noted that its employees do not make unsolicited contact with members of the public and do not solicit payments or seek personal information outside the bounds of formal enforcement actions. Furthermore, the SEC asks that anyone who receives a communication falsely appearing to be from the SEC submit a complaint to the SEC’s Office of Inspector General. [1]

Beyond this particular fraudulent scheme, the SEC has released several similar investor alerts in recent years. In general, impersonations of SEC and other government staff target victims who may trust the communication due to the seemingly serious nature of the communications and the illusion that the communications have come from trustworthy government actors.

In 2018, the SEC discovered instances of social media accounts impersonating the SEC and urged investors to independently verify that any social media account they engaged with and which purported to be connected to the SEC was in fact SEC-affiliated.[2] The SEC also reminded investors that per their policies, no SEC official would discuss nor endorse specific investments over social media. [2]

In our increasingly connected world, investors are encouraged to remain vigilant and skeptical of unsolicited communications asking for personal or financial information. And as always, please reach out to your trusted advisor or attorney at Savage Villoch Law with any questions or concerns.

Sources: [1] https://www.investor.gov/introduction-investing/general-resources/news-alerts/alerts-bulletins/investor-alerts/beware-0 [2] https://www.investor.gov/introduction-investing/general-resources/news-alerts/alerts-bulletins/investor-alerts/investor-11

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