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.

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

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

The jury convicted Schena of three counts of securities fraud, two counts of payment of kickbacks, one count of conspiracy to pay kickbacks, two counts of health care fraud, and one count of conspiracy to commit health care fraud and conspiracy to commit wire fraud. [1] While he won’t be sentenced until early 2023, Schena faces a maximum of 20 years for each count of securities fraud alone. [1]

While this case draws quite a few parallels to the early-2022 trial and eventual conviction of Elizabeth Holmes, the founder of Theranos, it has thus far drawn far less media attention. [2] Still, Schena’s conviction provides another important glimpse into the dangers investors may face when dealing with alleged cutting edge or “revolutionary” technologies.

Schena was the president of Arrayit Corporation, a publicly traded company based in California’s Silicon Valley. [1] On the securities fraud counts, the evidence at trial convinced jurors of Schena’s elaborate scheme to defraud investors through false and misleading statements about the company’s operations and technology, along with failures to release Arrayit’s financial disclosures as required by the Securities and Exchange Commission (“SEC”). [1]

Arrayit purported to offer blood testing via a “revolutionary technology” that could use one drop of blood to test for a wide array of diseases. [1] Schena even dubbed himself the “father of microarray technology,” as part of his efforts to “lull” concerned investors into a sense of comfort even as they doubted the company’s legitimacy. [1]

Schena and his publicist further leveraged false press releases and tweets, purporting to evidence partnerships with governmental entities and large companies, as part of the scheme to build false investor confidence in Arrayit. [1] As some investors began expressing doubt in Arrayit’s technological capabilities, Schena continued to falsely represent that the company’s valuation sat above $4 billion. [1]

Separate and apart from Schena’s investment fraud scheme, the jury also concluded that Schena perpetrated a scheme involving illegal kickbacks and health care fraud. [1] These schemes involved allergy testing, which Arrayit would run on every single one of its patients irrespective of medical need. [1]

While Arrayit’s allergy tests were not even diagnostic tests to begin with, the company touted their accuracy in diagnosing allergies, and paid kickbacks to marketers in order to obtain additional blood samples to test. [1] Arrayit then billed Medicare and commercial insurers for these allergy tests at a rate higher than any other lab in the United States. [1]

Finally, in 2020 when the Covid-19 pandemic hit, Arrayit pivoted toward marketing its own Covid-19 test. [1] Despite the Food and Drug Administration’s refusal to conclude that Arrayit’s Covid-19 blood test was accurate enough to receive an Emergency Use Authorization, Schena continued to claim that Arrayit’s test surpassed PCR tests in accuracy. [1]

In all, Schena defrauded investors of more than $77 million through his various fraudulent schemes related to Arrayit. [1] This case is yet another illustration of the pitfalls investors can face when making investments in start-ups or other companies touting new and innovative technologies. Please reach out to a trusted attorney at Savage-Villoch if you have questions.

Source: [1] https://www.justice.gov/opa/pr/medical-technology-company-president-convicted-77-million-covid-19-and-allergy-testing-scheme [2] https://lawandcrime.com/covid-19-pandemic/federal-jury-convicts-tech-executive-in-first-of-its-kind-covid-19-testing-related-securities-fraud-he-even-lied-about-being-a-nobel-prize-candidate/

“Boiler room” operations are fraudulent schemes in which high-pressure, coercive sales tactics are used to induce clients into purchasing stocks or other investments. [3] Often, these operations consist of groups of salespeople working from offices in foreign countries who cold-call clients in an attempt to defraud them. [3] The salespeople involved in boiler room schemes are rarely licensed brokers, and the stocks they purport to sell may not exist at all. [3]

In the instant case, the DOJ alleges that the defendants conspired to commit securities fraud when they engaged in a boiler room scheme involving fake investment firms and shell companies used to mislead investors. [1] The alleged scheme operated from approximately June 2019 until August 2021, and defrauded English-speaking investors across the globe of more than $8 million. [4]

The defendants falsely held themselves out to prospective investors as employees of well-regarded investment firms, going so far as to fabricate websites and email accounts that appeared to be associated with these actual firms. [4]

Furthermore, the DOJ alleges that the defendants engaged in classic boiler room scheme telemarketing tactics to convince clients to wire large sums of money from their bank accounts to the defendants, under the false impression that they were purchasing securities. [4] Yet the defendants never invested the money, nor did they return the money to the victims. [4]

After stealing more than $8.4 million through this scheme, the DOJ alleges that the defendants went on to launder over $4.6 million of the stolen money, once again sending it overseas. [4] The proceeds were then split amongst the scheme’s conspirators. [4]

The SEC’s parallel civil action sheds additional light on the details of this boiler room scheme. According to the SEC”s February 9, 2022, complaint, the scheme primarily targeted retirement-age and elderly victims, whom the defendants convinced to purchase fake securities traded on U.S. exchanges. [ 2]

The complaint notes that Defendant Robert Leonard Booth operated boiler rooms with offices in both Thailand and Panama from 2019 until 2020. [2] Booth was not registered with the SEC in any capacity and worked in connection with other defendants who owned the various shell companies which victims were instructed to wire their payments. [2]

The group of fraudsters charged in this case stole the hard-earned savings of more than 140 unsuspecting victims. [2] As noted in the SEC”s complaint, this schemes particularly targeted elderly victims, highlighting the insidious nature of boiler room schemes within this particular vulnerable population. Of course, the hard-selling tactics employed by boiler room investment fraudsters could well mislead any prospective investor.

You can protect yourself from boiler room fraud by staying alert for a few key red flags commonly employed by these fraudsters. Some such red flags include offers for outrageously lucrative yet low-risk investment opportunities, a reluctance to divulge detailed information about the investment firm the salesperson works for, and references to secret or insider information. [5]

Additionally, investors are cautioned not to make immediate investment decisions over the phone or by email. Instead, it is important to carefully consider any potential investment opportunities by pausing and conducting research on the credibility of the firm and investment opportunity. [5] A simple way to check a stock salesperson who calls is to put their name into www.brokercheck.com and see what pops up.

If you think you have been impacted by a boiler room scheme or another fraudulent investment scheme, a trusted attorney at Savage Villoch law is ready to assist you in navigating your situation.

Sources: [1] https://www.justice.gov/usao-sdny/pr/five-defendants-charged-84-million-boiler-room-fraud-and-money-laundering-scheme [2] https://www.sec.gov/litigation/complaints/2022/comp25326.pdf [3] https://www.investopedia.com/ask/answers/what-is-a-boiler-room-operation/ [4] https://www.justice.gov/usao-sdny/press-release/file/1470416/download [5] https://www.forbes.com/sites/bartastor/2017/09/09/cracking-down-on-boiler-room-fraud-self-defense-tactics-to-fight-off-the-crooks/?sh=160a10e527ec

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/

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

By way of a brief overview, in January 2021 a group of about 100 stocks experienced monumental price and trading volume fluctuations. These stocks, many of which were consumer-centered companies with high brand awareness, gained rapid attention over social media platforms like Reddit and YouTube.

While the SEC’s report addresses the events and impacts of the meme stock phenomenon broadly, it focuses the bulk of its analysis around GameStop Corp (“GME”), arguably the most famous of the meme stocks.

The report notes that five factors – large price moves, large volume changes, large short interest, frequent Reddit mentions, and significant mainstream media coverage – all converged around GME in late January 2021.

In 2020, GME’s stock price swung substantially, starting the year at around $6 per share before falling to $3 in April and then rebounding to reach about $20 per share by the end of the year. [1]

Then, when Ryan Cohen, the co-founder of the popular pet-focused e-commerce company, Chewy, Inc., announced he would be joining GameStop’s board of directors on January 11, 2021, the stock took off. While GME traded at $20.65 per share that day, its rose to a high of $347.51 per share by January 27^th. Along with these price increases came similar increases in volume. Trading volume from January 23-29 averaged 100 million shares trader per day, more than 1,400% higher than average daily trade volume during 2020. [1]

As this market volatility unfolded, perspectives on its driving force into two main camps – those who touted GME as a prudent, even undervalued, investment because of its potential to break into the e-commerce market, and those who felt short interest was fueling the moves. [1] As social media users focused their attention on short interest from large institutional investors like hedge funds, a “short squeeze” on GME was triggered. The Reddit retail investors viewed themselves as fueling GME’s price increases, forcing hedge funds to close out their short positions at significant losses.

However, as GME and other meme stocks skyrocketed, some app-based trading platforms popular among retail investors placed temporary restrictions on trading in these stocks. The platforms cited various reasons for these restrictions, including margin calls from clearing agencies to cover increased risk. Conversely, retail investors believed that the restrictions were put in place in response to pressure from hedge funds with short positions at risk of losing money – claims that made their way to a Congressional hearing in February.

The SEC’s report ultimately provides a few important takeaways for the investing public. First, the report notes that it was “positive sentiment” about GME – whether a legitimate belief in GME’s fundamentals or a desire to profit from a rise in price – that fueled the sustained appreciation of GME’s stock price, not short-sellers who were “buying-to-cover.” [1] In fact, the report quite succinctly noted that “[s]taff believes that hedge funds broadly were not significantly affected” by the run on GME. [1]

Furthermore, the report also briefly touched on the rationale behind trading restrictions enacted by broker-dealers like Robinhood, noting that it had found evidence that clearing agencies had indeed demanded to be paid billions in additional margin by their member firms to account for volatility risks. [2]

The report concluded with four areas targeted for further study and consideration, noted as the following:

1. Forces that may cause a brokerage to restrict trading
2. Digital engagement practices and payment for order flow
3. Trading in dark pools and through wholesalers
4. Short selling and market dynamics. [1]

Each of these areas falls squarely within the ambit of SEC Chairman Gary Gensler’s already stated policy goals, inherent in his aim of promoting a more “fair, orderly, and efficient” market in the United States. [3] While the report did not outline specific improvements to be made, it serves as an important starting point for potential policy changes for protecting retail investor interests moving forward.

Sources:

[1] https://www.sec.gov/files/staff-report-equity-options-market-struction-conditions-early-2021.pdf

[2] https://www.latimes.com/business/technology/story/2021-10-18/sec-gamestop-report-debunks-conspiracies-backs-commission-chiefs-plan

[3] https://www.barrons.com/articles/sec-report-changes-what-we-know-about-januarys-gamestop-frenzy-51634590024

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

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/

At the heart of the civil and criminal complaints against Nikola are allegations that as its CEO, Trevor Milton, regularly spread false and misleading information about the progress of Nikola’s EV products and technologies. Nikola’s focus is on manufacturing low- and zero-emissions trucks, and the complaints allege in part that under Milton, Nikola published a promotional video of a prototype truck which did not actually work, but appeared to only because the truck was set in neutral and rolled down a hill. [1]

Promotional videos like that one, along with Milton’s enthusiastic social media posts and numerous podcast and television appearances, all painted a picture of exciting and impressive forward progress at Nikola, which Federal prosecutors and SEC regulators allege was nothing more than an illusion. [2]

This illusion allegedly created by Milton came at a steep cost – and was seemingly targeted retail investors in particular. Nikola went public via a Special Purpose Acquisition Company (“SPAC”) in June 2020, and once it began trading publicly, the value of its shares increased by $7 billion. However, Nikola’s value dropped steeply once the public learned of ongoing federal investigations into the company and its operations, leading to huge losses borne by retail investors who had been misled. [1]

Of course, EV companies and their executives are in a unique position given the bounding public interest in, and relative infancy of, the EV market. When attempting to evaluate a new or existing EV company, projections into the future must be made, and no fool-proof roadmap for this technology currently exists.

However, these uncertainties pose a particularly risky situation for prospective retail investors who can be easily misled by companies making false claims about their highly complex products or technologies – especially when, as here, these claims are being shared rapidly over social media.

Here, Nikola’s non-traditional IPO process put unsuspecting retail investors at even greater risk. When a company goes public via a SPAC, the traditional “quiet period” after a company is publicly listed is not required. This allowed Milton to continue amplifying false claims about Nikola on social media just after going public, thereby attracting additional retail investors, and driving the stock price up further. [3]

In pursuing these securities fraud charges against Nikola, the SEC continues to signal its sharp focus on SPAC regulation in the interest of protecting investors. As we all navigate the rapid influx of SPACs along with the continued push for broad adoption of EVs, retail investors should continue to carefully research prospective investments by identifying concrete achievements such as milestones hit and actual sales or delivery figures to date, while steering clear of “bandwagon effect” investing. These careful considerations, along with continued scrutiny by regulators, are some of the best ways to protect your assets in the market.

Sources:

[1] https://www.marketwatch.com/story/nikola-electric-truck-prototypes-were-powered-by-hidden-wall-sockets-towed-into-position-and-rolled-down-hills-prosecutors-say-11627572394

[2] https://www.sec.gov/news/press-release/2021-141

[3] https://www.nytimes.com/2021/07/29/business/nikola-trevor-milton-fraud.html

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

Margin debt can be simply understood as debt taken on by an investor in order to extend their buying, and earning, power in the market. In essence, an investor borrows money to increase their initial investment and, hopefully, to supercharge their eventual profit.

For example, an investor might borrow $10,000 from their broker on margin in order to increase their initial investment from $20,000 to $30,000. If the shares they’ve purchased increase by 10%, the investor stands to make 50% more than they would have with only their own $20k.

Of course, taking on margin debt is also highly risky. When an investor’s balance falls below the minimum amount required by the broker, they may face a margin call. This margin call requires the investor to deposit more money or securities to maintain the broker’s minimum required value within the account.

Trading on margin is an attractive option when investors feel optimistic about the future of the security they’re investing in, or the overall market. However, this practice may have detrimental, rippling impacts within the market. Because borrowing on margin adds additional investment money into a particular stock or stocks, high levels of margin may actually begin to create a bubble. [2]

Excessive margin debt can be symptomatic of these speculative market bubbles, and eventual bursts, because it may signal overexuberant investor behavior, behavior that is not fully based in fact. As a result, several experts agree that exceedingly high levels of margin debt may signal an impending market drop.

In fact, sky-rocketing levels of margin debt have preceded both of this century’s extended economic downturns. Just before the dot-com bubble burst in 2000, margin debt was up more than 80%, and before the great recession in 2008, margin debt had risen by over 60%. [3] For context, margin debt is currently up more than 50% since this time last year and has risen 10.5% to date in 2021.

While high levels of margin debt are but one indicator of a potential market downturn, they are a critically important one to watch. In 2000 and in 2007, the S&P hit its own peak just a few months after margin debt peaked. Similarly, once margin debt hit its lowest point in 2009 following the recession, the S&P hit bottom just one month later. [4] The takeaway: the cyclical and relational nature of margin debt and overall market performance is not to be ignored.

The popularity of trading on margin has exploded, particularly in light of the newfound ease of doing so through popular app-based platforms like Robinhood. However, it is important for investors to keep in mind the broader market implications that an abundance of such trading may have, potentially in the near future.

Sources: [1] https://www.finra.org/investors/learn-to-invest/advanced-investing/margin-statistics [2] https://www.gobankingrates.com/money/economy/signs-of-market-bubble-crash-what-to-expect/ [3] https://www.fool.com/investing/2021/06/12/whos-ready-stock-market-crash-5-reasons-big-drop/ [4] https://www.advisorperspectives.com/dshort/updates/2021/07/20/margin-debt-and-the-market-up-2-4-in-june-continues-record-trend

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/

There are some situations in which FINRA arbitration is required, such as when a written agreement between the parties mandates it. In order to be eligible for FINRA arbitration, an investor must be seeking to file a claim stemming from the business activities of their broker or brokerage firm, and the event in question must have taken place within the last six years (in most states). [1]

Generally, FINRA arbitration allows an investor to seek either monetary or securities damages resulting from the business activities of their broker or brokerage firm. To get the filing process started, an investor must submit a Statement of Claim, a FINRA Submission Agreement, and related filing fees, all of which are available to view on FINRA’s website. [2]

The format and related fees for the arbitration itself vary based on the amount of money in controversy. When the amount in controversy is below $10,000, a hearing session will be conducted with just one arbitrator, and the session fee will be between $50 and $450. If the amount in controversy is above $10,000, a panel of three arbitrators may be used instead, and the hearing session fee will range from a minimum of $600 to a maximum of $1,575. [3]

Once FINRA receives all of the initial required documents, they analyze the claim and determine whether a one- or three-person arbitration panel will be used. A case number is created, and FINRA will notify the respondent – the party the investor has filed their claim against – about the case. So long as the respondent is registered with FINRA, they will be required to arbitrate.

The respondent then has 45 days to research the claim lodged against them and to respond. FINRA analyzes the response along with any counter claims or cross claims.

Next, the parties choose their arbitrators from a randomly generated list of names supplied by FINRA. FINRA arbitrators are not FINRA employees, instead they are contractors who are evaluated by FINRA on the basis of their employment, professional licenses, and education. They are chosen from diverse backgrounds and must take an oath to remain neutral and decide cases solely on the facts and meris.

Once arbitrators are chosen and agreed upon by both parties, there will be an initial pre-hearing conference, where investors are typically represented by an attorney. The arbitration hearing is scheduled, and discovery begins.

Discovery allows both parties to exchange documents and identify witnesses and is governed by rules within FINRA’s Discovery Guide. After discovery is completed, the arbitration hearing takes place.

The arbitration hearing takes place around a conference table, with arbitrators at the head of the table and the parties on each side. The claimant presents their side of the case first, complete with an opening statement, witnesses, and evidence, and is followed by the respondent. Objections are permitted, and the arbitrators determine whether or not they will accept evidence.

At the completion of the hearing, the arbitrator(s) will deliberate, and render their award, typically within 30 days. The award is legally binding on both parties, and FINRA offers no internal appeals process. While a party may choose to appeal an arbitration award in court, it should be noted that judges rarely overturn these awards.

From start to finish, FINRA arbitration cases that don’t settle before their hearing take approximately 16 months. The process allows for a streamlined and more private alternative to litigation in the courtroom, as FINRA arbitration documents are not made public like court documents. We invite you to contact us for details and support on your potential FINRA arbitration claim.

Sources: [1] https://www.finra.org/arbitration-mediation/arbitration-overview] [2] https://www.finra.org/sites/default/files/Education/p117486.pdf [3] https://www.finra.org/rules-guidance/rulebooks/finra-rules/12902]

Let’s consider an example of margin investing with Robinhood. An investor deposits $5,000 cash into a margin account, and Robinhood lends another $5,000 to allow the investor $10,000 worth of securities. The “margin” is the difference between the value of the securities and the loan from Robinhood. This type of investing increases both purchasing power and financial leverage. [1]

If the securities in the margin account increase in value, the investor has the opportunity for a higher profit than they would have had they invested $10,000 of their own.

On the other hand, if the securities decrease in value, the margin investor is at risk of losing more than they would have had they invested $10,000 of their own.

One of the most significant risks of margin investing stems from margin calls. Because securities purchased on margin are used as collateral against the loan Robinhood extends, Robinhood sets “margin maintenance requirements” on each margin account. These requirements are minimum portfolio values that must be maintained by the investor, and they help Robinhood protect the money they’ve loaned. [2]

So, if the market is volatile, as it has been recently, and the value of securities in a margin account falls too far, Robinhood will issue a margin call. The investor must then either deposit additional cash into their account to meet the margin maintenance requirement or close out their position(s).

However, per Robinhood’s Margin Account Agreement and Margin Disclosure Statement, when Robinhood issues a margin call, they also have the right to sell the account holder’s securities without notice nor consultation. [3],[4]

The language of the agreement specifically states that Robinhood is authorized to liquidate or sell the securities in a margin account to cover any margin deficiency, and that they are not required to notify the account holder before making such a sale. The agreement also stipulates that Robinhood has the sole authority to choose which securities are sold in order to satisfy a margin call, and that Robinhood’s margin maintenance requirements are subject to increase at any time, with no advanced written notice required. [3],[4]

Based on this agreement, which all Robinhood margin investors are required to sign, Robinhood has quite a bit of power over margin accounts. Understood in context, however, these stipulations are designed not to put the investor at risk, but instead to allow Robinhood to protect the money they’ve loaned to investors via immediate liquidation and/or covering losses by requiring additional cash deposits. [3],[4]

Margin investors should also be aware that Robinhood’s margin account agreement explicitly states that any disputes must be resolved via arbitration, so neither party to the agreement may sue one another in court. If a dispute arises, an arbitration case would be filed with the Financial Industry Regulatory Authority (FINRA) in order to reach a resolution or settlement. [3],[4] FINRA arbitration is designed to create a fair and expedited alternative to a traditional court case, but it’s important to understand the arbitration process before deciding to make the leap into margin investing.

So, depending on your risk tolerance, margin trading may or may not be an investment tool you want to use in your accounts.

In our next post, we’ll be sharing a start-to-finish overview of what you can expect from the FINRA arbitration process, particularly as it pertains to margin investing.

Sources: [1] https://www.investopedia.com/ask/answers/041315/why-purchasing-stocks-margin-considered-more-risky-traditional-investing.asp [2] https://robinhood.com/us/en/support/articles/margin-overview/ [3]https://cdn.robinhood.com/assets/robinhood/legal/RHS%20Customer%20Margin%20and%20Short%20Account%20Agreement.pdf [4]https://cdn.robinhood.com/assets/robinhood/legal/RHS%20Margin%20Disclosure%20Statement.pdf

Starting with the basics, what is a non-fungible token?

An NFT is a type of digital, cryptographic asset which exists on blockchain. Fungibility refers to interchangeability – assets like dollars, gold, and even Bitcoin, are fungible, because each unit is worth the exact same amount, and is thus readily interchangeable. On the other hand, each unit of a non-fungible asset has its own unique value and thus is not readily interchangeable – think of assets like property, artwork, and other collectibles. [1]

NFTs derive their value from their uniqueness. Each NFT has its own identification codes and related data within the blockchain to distinguish itself. It is impossible to replicate an NFT, which helps to create rarity among NFTs akin to that of traditional and tangible collectibles.

While there are several possible use cases for NFTs, the market is currently largely focused on collectibles. In particular, the popularity of digital artwork NFTs has skyrocketed in 2021. Artists are excited about this new market, as NFTs eliminate the need for intermediaries like art brokers, thereby increasing market efficiency. Artists can now post their artwork on digital marketplaces like OpenSea where anyone in the world can browse and purchase using blockchain-based cryptocurrencies, like Ethereum. [2]

But when you buy an NFT, what do you actually get? In the case of digital collectible NFTs, you are getting not only the digital piece of art, but also the NFT’s unique code and data on the blockchain. The value of the NFT comes from its unique identifiers. You are not, however, getting any intellectual property rights to the piece of art – those still belong to the artist.

Instead, much like physical pieces of art or baseball cards, you are paying to own an “original” or collectible item. For example, when Jack Dorsey sold an NFT of his first tweet, the buyer received a unique token on the blockchain that cannot be replicated. But that does nothing to change the fact that anyone with internet access can look at the tweet, screen shot it, or save a picture of the tweet on their phone.

The concept may seem nebulous to some, but its not so different from physical collectibles. It’s widely accepted that certain early edition baseball cards have inherent value to collectors. If someone were to simply take a picture of one of these collectible cards, that would do nothing to decrease the value of the original card, and similarly, would not suddenly give value to the picture someone took of it.

Of course, rarity alone does not necessarily equate to value – actual interest within the market participants of owning the NFTs is also essential. But it is yet to be seen whether this is what makes NFTs such an interesting and risky investment opportunity.

Many people are currently buying NFTs speculatively, not to own them long-term, but rather with the aim of selling them at a profit sometime in the future. While some NFT purchasers have already made huge sums of money in this way, it remains to be seen whether the current NFT craze will endure, or whether this is a passing fad brought on by the uncertain and unprecedented circumstances we’re all currently under.

In sum, NFTs present an equally intriguing and risky investment opportunity. If you are interested in the market, you should approach the decision to invest with extra care as the NFT market continues to develop and additional use cases and capabilities are explored.

Sources: [1] https://www.investopedia.com/non-fungible-tokens-nft-5115211 [2] https://www.nytimes.com/2021/03/11/arts/design/nft-auction-christies-beeple.html

The first cryptocurrency, Bitcoin, was introduced in 2009, and it has since been joined by over 1,900 competitors. Cryptocurrencies operate in a decentralized, purely digital block-chain network. Within the network, a supply cap on “coins” exists, and coin production is left in the hands of collective members of the system through a process known as “mining.” In Bitcoin’s case, there can only ever be 21 million coins mined, of which over 18 million have been mined thus far. Cryptocurrencies like Bitcoin derive their value largely from their limited supply, overall market demand, the cost to produce a bitcoin via mining, and competition from other cryptocurrencies.

Recently, Bitcoin’s price has been on the rise, stirring up a good deal of interest from prospective investors. As of February 6, 2021, one bitcoin is worth $39,255.90 –up about 300% year over year, and 34% year to date. But an investment in Bitcoin, or other cryptocurrencies like it, is unique in its risks. Experts caution that because cryptocurrency is a relatively new technology, and is not yet well understood by the public, prospective investors are at an increased risk of falling victim to fraudulent schemes.

From a regulatory standpoint, the SEC currently categorizes bitcoin as a security. However, bitcoin differs significantly from a traditional stock or bond because it does not represent shares of a corporation– it has no balance sheet, it is not impacted by government-imposed monetary policy or inflation rates, and its digital format makes it extremely difficult for regulators to access. As a result, cryptocurrencies like Bitcoin offer fraudsters a prime opportunity to engage in predatory behavior against investors.

This week, the US Department of Justice brought two recent cryptocurrency schemes to light. First, on February 1, 2021, a California man, John DeMarr, was charged with one count of conspiracy to commit securities fraud for soliciting investments in two companies he owned, which he misrepresented as highly profitable online cryptocurrency mining and trading platforms. DeMarr lured investors in with celebrity endorsements and fake press releases. But rather than investing his victims’ money in cryptocurrency technologies, DeMarr defrauded them of over $11 million, using the funds to furnish his lavish lifestyle instead.

On February 4, 2021, another cryptocurrency scheme unfolded as the 24-year-old founder of a cryptocurrency hedge fund pleaded guilty to one count of securities fraud. Stefan He Qin owned two cryptocurrency hedge funds which he told investors carried minimal risk because they were not impacted by volatile swings in cryptocurrency prices. Qin managed more than $90 million for his investors, which he used for personal expenses while providing his investors with falsified monthly investment performance reports.

These are just two instances of cryptocurrency fraud, but they are symptomatic of a growing trend in the cryptocurrency market. Eager investors looking to get involved in cryptocurrency and related technologies should exercise caution when making their investment decisions. The SEC has recently published an investor alert titled “Ponzi Schemes Using Virtual Currencies” which points out several red flags to be aware of, including investments touted as carrying little or no risk, unlicensed sellers, and investments requiring no minimum investor qualification.

While cryptocurrencies present an exciting investment opportunity for some, prospective investors should keep in mind their myriad risks, and regulators should continue to develop strategies for identifying and deterring fraudulent cryptocurrency schemes.

As has been widely reported this week, when Reddit retail investors discovered that hedge fund managers were widely shorting GameStop, AMC, and others, they urged fellow users to begin buying up these stocks. This frenzy of investment activity resulted in a short squeeze, sending GameStop’s stock price soaring, causing hedge funds to incur huge losses on their short positions, and placing popular online trading platforms in a precarious financial situation. GameStop shares closed the week of January 25, 2021 up 400% in spite of market volatility and restrictions, and without any material change to the prospects of company.

But how did we get here?

For one, through the rise of simple, fee-free, online investment platforms like Robinhood. These platforms have empowered retail investors by providing an easy-to-use interface to enter the market and trade shares at the click of a button. But this innovation hasn’t come without its critics, who counter that the platforms may paint investments as form of gambling for users who may not have the requisite knowledge to make informed decisions about the risk they take on in their accounts.

As trading activity exploded on Robinhood this week, the platform became strained and suspended trading on a group of 13 popular stocks on Thursday, January 29^th. The restrictions disallowed further purchasing of the stocks but allowed selling – making it difficult for prices to continue to rise. As reported by the New York Times, in order to continue operating Robinhood needed funds to pay both its clearing facility and its users who were owed money from prior trades. To that end, Robinhood raised over $1 billion from its credit lines on Thursday night, enabling trading to resume on Friday, albeit with significant stock-quantity restrictions.

Of course, this period of restricted trading has raised some important legal and regulatory questions. First, some Robinhood users viewed the trading restrictions as unjust behavior in the free market, with over a dozen lawsuits, including a class action, filed against the company this week. The lawsuits claim that Robinhood breached its contract with users when it began restricting their trading activity. Further, the class action lawsuit claims that Robinhood’s “actions were done purposefully and knowingly to manipulate the market for the benefit of people and financial institutions who were not Robinhood’s customers.”

According to several legal experts cited by Thompson Reuters, it is unlikely that these lawsuits will succeed, because Robinhood’s user agreement reserves the right to “prohibit or restrict” its users from trading securities at its own discretion. Additionally, federal securities law places strict limits on class actions against brokers, and users will face the tough task of proving the specific damages they suffered because of the restrictions. They will also likely need to show concrete evidence that Robinhood’s restrictions were made for an some “improper reason, such as to favor certain investors” to succeed.

Given the intense public scrutiny and media attention, it’s difficult not to wonder what comes next. In the regulatory realm, the SEC has released a statement vowing that they “will closely review actions taken by regulated entities that may disadvantage investors or otherwise unduly inhibit their ability to trade certain securities.” In fact, the SEC has already had its eyes on Robinhood in recent months. They issued a $65 million fine against the company in December 2020, alleging that Robinhood misled its customers about their main revenue source, causing users to lose $34.1 million between 2015 and 2018.

With commitment this week from both the White House and Treasury to monitor the situation, along with bipartisan support in Congress to investigate, this fast-evolving situation will be one to watch in the coming weeks.

According to the Financial Times, during the ‘consultation period’ when the Securities and Exchange Commission considers comments made about their proposed changes, 2.262 letters were submitted to the Securities and Exchange Commission regarding the proposed change to the disclosure rules. Of these 2,262 comment letters, 99% were against the proposed rule, according to Financial Times. The result of such a large number of letters opposing the rule change is that the Securities and Exchange Commission is expected to withdraw its proposal and keep the current disclosure threshold of $100 million.

The $100 million threshold has been in place since 1975 and it requires hedge funds to file a “13-F” report each quarter to disclose their holdings. The Securities and Exchange Commission looked at the fact that the US equity market capitalization has grown from $1 trillion to an $35 trillion and decided that it was time to raise the disclosure limit. The Securities and Exchange commission also claimed that the disclosure requirements at $100 million were a burden to the smaller hedge funds. This reasoning leaves out the impact that its actions would have on the transparency of the markets. The Financial Times reports that hedge fund managers were skeptical of the Securities and Exchange Commission’s reasoning. The smaller hedge fund managers and even the CFA Institute noted that the costs to file the 13F are negligible and the process was mostly automated by today’s portfolio accounting software programs.

There are plenty of reasons why the proposed rule change is a bad idea that would have long term negative effects on the securities markets. The financial markets need to be as transparent as possible to protect investors and the integrity of the public securities markets. Whenever rules create additional options for hedge funds to obscure their investments, the individual investor is at a disadvantage. The individual investor should have access to understanding the positions taken by hedge funds because it can help guide their own investing and provide clues as to how the ‘experts’ value an investment that an individual investor may want to make.

Financial Times noted that another potential problem with the proposed disclosure threshold increase is that it would permit activist investors to accumulate larger stakes in companies, thus forcing companies to develop new strategies for dealing with activist investors. An ‘activist investor’ is one who buys shares in a publicly traded company in order to get board of director seats and then work to make significant changes to the target company. This may sometimes be beneficial for the target company but it could also lead to negative impacts by derailing management’s plans to grow the target company and ultimately hurting shareholders of the target company.

The New York Stock Exchange’s letter warned that small and medium size publicly traded companies could be hardest hit, according to Financial Times. Since smaller companies have a smaller ‘float’ of shares, an activist company could quickly purchase a significant portion of the company’s shares and in effect take over the company from its current managers by obtaining multiple board of director seats and thus call the shots.

The outpouring of resistance by hedge funds, publicly traded companies and large pension funds to the Securities and Exchange Commission’s proposed rule change is a welcome sign in a world where many people may believe that Wall Street is trying to take advantage of them. Let’s hope that the Securities and Exchange Commission does withdraw this rule change proposal.